Archive for the ‘Value Letters’ Category

We start off with an observation that may appear self-evident:

  1. Great investors are not necessarily great businessmen and
  2. Great businessmen are not necessarily great investors

This has created an interesting paradox. How can different people have such different views on the same subject matter – chiefly the investments in common stocks?

What happens in the business world and what is taught in the vast majority of finance courses is striking different. For example the projecting of future cash flows or the calculation of intrinsic values of business are uncontroversial parts of any business school curriculum.

Approach a businessman with the same set of projections and hilarity ensues.

How can financial analysts proclaim to have precise calculation of business values when management themselves do not know with precision what lies ahead in the coming year? How can two experts in their field arrive at vastly different conditions?

My own observation and hypothesis is that both people are in fact looking at different sides of the same coin. The failure to appreciate the other point of view lies in the entrenched thinking that each possesses the entire tool-kit to analyze the issue at hand.

As Charlie Munger put it poignantly, “To the man with a hammer, everything looks like a nail.”

Let’s take enquiry a step further by engaging in what admittedly is an exercise not steeped in empirical research but my own observation and reasoning. It does not reflect that my own view is necessarily correct, but I hope it reflects the sincerity of my opinion.

As an individual with a legal background, I routinely deal with unquantifiable unknowns and the tool-set which we use to derive a solution involves a heavy use of precedent, observation and deductive reasoning.

Based on current academic research, we can say with a high degree of confidence that the average individual does not engage in reading or learning outside his or her job. The vast majority (or the consensus opinion) is thereby a rough reflection of the existing state of knowledge that is most commonly accepted within that period of time.

It is the nature of higher education that we are pigeon holed into “silos” of academic knowledge. You have accountants, lawyers, manager, financial professionals and so on. When analyzing a business however, the view of each tells a different part of the same story, albeit from a different point of view.

My own observation of courses that are meant to promote holistic thinking are that they are far often treated like a slideshow to the man event. Specialists in their respective field it seems are more richly rewarded than generalists.

There is a large degree of truth to this observation. What practical use is knowledge of history, ancient civilizations, languages and culture on a relative basis compared to the hard skills that lead to immediate financial rewards?

A technician or engineer is first hired not to allocate capital but to solve technical problems at an immediate and practical level. The route that the vast majority of market participants take is therefore quite rational.

The efficient market theorem postulates that the price today on an asset reflects its “correct” value.

Let’s try to dig deeper into what this really means.

Markets are inherently made up to buyers and sellers that are essentially institutions or individuals. The vast majority of these individuals are however untrained for the most part in financial analysis and business management. They represent people from all walks of life. Thus, what the market in essence reflects is what market participants with their own knowledge and experience think the asset is worth as opposed to what the asset value is inherently worth.

Although intrinsic values & perceived value may coverage, there are frequently times they do not.

I realize that I am now approaching on area that seems to have no definite or absolutes. We have left the realm of precision and entered the uncertain world of relatives. How does one measure the value of something if conventional models do not work?

Experience has taught us that to understand how the financial markets work, you need to grasp the fundamentals of human psychology and neuroscience. The field of behavioral economics shows great potential in unlocking these mysteries.

Consider this.

It is well known that different people can have vastly different inspections of the same event. The brain deletes, distorts and outright manipulates what we think we see as opposed to what really happens. However, there must ultimately be only one true account of the incident. In the court it is often the role of judges to piece the most rational and plausible explanation of what happened.

The same is true in investing. Take for example a hort term price decline in the price of a company as a result of an earnings miss. The result in the short term is often a knee-jerk reaction, based upon the experiences of those who are actively buying and selling in that instance.

The motion of a mis-priced, undervalued security provides a logical conundrum. How can a security be mispriced and not be snapped up to its right value? And again how can an overpriced security be overpriced? Can it be said that the markets are truly efficient when the share price of a stock trades at $200 on one day and $0 in the next year? These are some of the questions that we will continue to explore in our subsequent memos.


Read Full Post »

Dear Clients,

As a general policy, we refrain from giving specific investment ideas. There is little upside to revealing our investments in specific, publicly traded companies. On the contrary, there is significant downside in telegraphing our methods and trade secrets that will ultimately hamper our ability to act discretely and quickly.  I will thus refrain from discussing specific investment ideas outside of regulatory requirements.

What I hope to impart through these memos is the business and investment policy of our partnership. We are not in the business of predicting the fluctuation of markets. Our expertise lies in seeking out discrepancies between value of price in mis-priced securities i.e common/preferred stock, warrants or bonds.

We view shares in a company as a very real & tangible ownership in the business. Mindful of the fact that we are minority shareholders, we typically seek businesses that are awash in cash, either as a result of their intrinsic earnings power or from the potential liquidation value of their assets.

While most investors typically treat the market like a casino, we take a different view. It is a constant that investment markets exhibit the same pendulum like swing time and time again between unwarranted euphoria and downright depression.

As avid students of the financial markets, we note with confidence that these price fluctuations often have little bearing on the economic condition of the business itself. We stand with conviction not because of unwarranted optimism, but cautious practicality. We place a large emphasis on the presence of tangible assets and demonstrated earnings power to help serve as anchors to reality.

This long term approach help sets us apart from the crowd. There are no free lunches in the world, none the more so in investing. At the heart of our investment policy is a central question we ask ourselves: Would we take control of entire ownership of the business given the chance?

If the answer is no, we do not hesitate to seek better investment opportunities.

Our job is to deliver longterm returns and not to focus on short term out-performance. A common question that often follows is whether investing is really just down to luck?

The answer is not at all. In the short run, any investor can make money through outright speculation and even magnify his returns with the use of leverage. On the basis, luck plays a crucial role in your success.

However, over the course of hundreds of investments, skill inevitably matters more. No matter how one rationalizes it, luck is not a consistent long term strategy to building wealth.

Most of the investment operations that we undertake in are unorthodox and other run against the grain of “common wisdom”. Our investment philosophy frequently leads us to businesses experiencing temporary economic distress. We favor such investments not for the sake of acting in a contrarian manner, but because they afford better opportunities for out-sized gains.

While seeking investments in distressed assets, we are mindful of John Maynard Keyne’s maxim, “Market can remain irrational longer than you can remain solvent.” We only seek investment opportunities that have the demonstrated capacity to withstand persistent declines in economic conditions.

We will eschew the use of leverage in the vast majority of circumstances. Our chief most responsibility is firstly the protection and preservation of the capital under our stewardship.

It is our firm belief that if one can avoid the losses; the winners will take care of themselves. This also explains our propensity to favor businesses that are backed up with substantial asset values. They are in our experience much more reliable determinants of value than projected earnings.

Read Full Post »