Collins BIS represents fund managers who adhere to value investing strategies. Value investors look for companies whose securities are selling at deep discounts to their intrinsic value—the price a knowledgeable buyer would pay for the entire business. Deep discounts provide a cushion to investors, or a margin of safety, in the event of stock market declines. Value investors seek to preserve capital.
The origins of value investing date back 80 years, when Benjamin Graham and David Dodd, two professors at Columbia University, published their 1934 classic, Security Analysis. The book outlined their search for a rational alternative to the speculation and insider trading that dominated stock market investment decisions and that had impoverished so many investors.
Warren Buffett is arguably the world’s best-known value investor, but the strategy has other notable adherents including William Browne, Joel Greenblatt, Seth Klarman, Charlie Munger, Michael Price, John Templeton, Marty Whitman, and a few others we prefer to keep secret.
Benjamin Graham introduced this term in The Intelligent Investor (1949), when he wrote, “To distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY… The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.... The margin of safety is always dependent on the price paid. It will be large at one price, small at some higher price, nonexistent at some still higher price… To have a true investment there must be present a true margin of safety.”
Seth Klarman states, “Value investors seek a margin of safety, allowing room for imprecision, bad luck, or analytical error in order to avoid sizable losses over time… Value investors invest with a margin of safety that protects them from large losses in declining markets ... By finding securities whose prices depart appreciably from underlying value, investors can frequently achieve above average returns while taking below average risks.”
Warren Buffett said, “We believe the margin of safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success.”
Seth Klarman said a couple of things that should get our attention. “One of Baupost’s biggest advantages is that our clients have long time horizons. Our ability to maintain a long-term, absolute performance discipline in a short-term oriented world is crucial. Our typical time horizon… is several years or longer.” He also said, “We are always long-term oriented. We are resolute in resisting the short term performance pressures and herd behaviors that plague the investment business.”
Warren Buffett adds, “Time is the friend of the wonderful business, the enemy of the mediocre. The market may ignore business success for a while, but eventually will confirm it. In fact, delayed recognition can be an advantage: it may give us the chance to buy more of a good thing at a bargain price.”
Peter Lynch of Magellan found that “Time is on your side when you own shares of superior companies. You can afford to be patient, [because] ultimate success depends on allowing your investments [time] to succeed.”
You know long time horizons are the right thing to do. Don’t get caught up in the short-term performance derbies that dominate institutional investment programs.
Our circle of competence is limited to things we do extremely well. It does not have to be large. Warren Buffett says, “The size of that circle is not very important; knowing its boundaries, however, is vital… What an investor needs is the ability to correctly evaluate selected businesses. You only have to be able to evaluate companies within your circle of competence.”
He continues, “What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know… If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter.”
Charlie Munger adds, “Warren and I tend to avoid [certain things], based on our personal inadequacies. That is a very powerful idea. Everybody is going to have a circle of competence.”
The point is, we should not be doing things that other people can do much better. If we step outside our circle, we will underperform, lose money, and – as Seth Klarman puts it – “We’ll get our eyeballs ripped out!”
My favorite shape is the triangle. Why is the triangle my favorite shape? It’s the reason for much of my success. I think it’s the reason for a lot of other people’s success. I call it the “Networking Triangle.”
There are upwards of 200,000 professionals in the investment industry. Most of them have a herd mentality. They feel secure running with the pack. They find safety in numbers. There is no career risk by following a well-worn path. Yet somewhere in the mix are those who think for themselves and stick with their decisions, no matter what the markets may be telling them. Those are the people you want to know.
Imagine a triangle four feet high with a two foot base into which we would rank everyone in our industry, ranked by success based on skill, not luck. 75% of the industry pros would fall into the bottom half of that triangle. They have nothing to offer you. They have less ability than you do and—because you have limited time—you cannot waste it there. You want to network with the professionals in the top half of the triangle, the top 25%.
It sounds simple, and it is. To supercharge your potential in this industry, and to cut in half the time it takes to get to the top—network up, and build professional friendships. As an aside, networking up with investment professionals is the most efficient way to build your circle of competence. And that suggests the importance of building long-term strategic partnerships with your investment managers.
Does it always have to be value or growth? Warren Buffett thinks not. He says, “Most analysts feel they must choose between two approaches customarily thought to be in opposition: ‘value’ and ‘growth’. Many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing. We view that as fuzzy thinking.” And Charlie Munger continues, “All sensible investing is value investing. Growth is merely one component of value.”
Buffett explains, “In our opinion, growth is always a component in the calculation of value, consisting of a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive. A fast-changing industry environment may offer the chance for huge wins, but it precludes the certainty we seek.”
Peter Guy, the great Australian investor, has a different take. He says, “I’m 100% a Buffett/Graham investor, but the Holy Grail of investing is to find growth. I want stocks that will go up six, seven or ten-fold like Peter Lynch’s 10 baggers.”
Of all the commodities in short supply, time leads the list. It is neither fungible nor replaceable. It cannot be delegated, and a committee always does a worse job with it than an individual. And while it is never quoted on any exchange, undisturbed thinking time is the most precious item in the world. How do we get more of it?
One way is to follow a brilliant CIO that participates at most of our winter Colloquiums. He sets aside 30 to 90 minutes each day with his office door closed, and his phones and computers turned off. He calls it the most important time of his day, reserved solely for thinking.
It’s been said that a thinker’s mind takes more effort to build than a weightlifter’s body. Seth Klarman sums it up by saying, “We have to slow down and think.”
Volatility is not risk. It provides investors with buying and selling opportunities. Seth Klarman says, “Investors should expect prices to fluctuate and should not invest in securities if they cannot tolerate some volatility. The trick of successful investors is to sell when they want to, not when they have to. Long-term-oriented investors are interested in short-term price fluctuations [because] Mr. Market can create very attractive opportunities to buy and sell.”
Warren Buffett says, “The true investor welcomes volatility. A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.” Peter Lynch puts it this way: “A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm and panic.”
Risk is permanent loss of capital. To this, Ken Fisher adds, “Investors regularly flee stocks to avoid volatility – robbing themselves of potential future returns. Stocks are volatile. The market is volatile. And you want it to be.”
