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.