Street Capitalist: Event Driven Value Investments

This past weekend was the Berkshire Hathaway (NYSE:BRK.A / BRK.B) annual shareholder meeting. At one point during the Q&A, a questioner asked Warren Buffett about the status of Berkshire’s CIO candidates. Charlie Munger remarked that one candidate who he is particular close with was up 200% in 2009 with 0 leverage. Some people think that the person Munger is referring to is Li Lu, a fund manager who turned Munger and Buffett onto BYD.

Lu personally owns at least 2% of BYD, which rose 400% in 2009. I don’t know anything about his investments beyond that one position, but I know he is a huge believer in taking concentrated, high conviction positions. If that is the case here, BYD’s spectacular results must have contributed a lot to his returns for 2009 which may make a 200% for the year possible.

Here is a brief bio on Lu:

Li Lu was born in China in 1966. He attended Nanjing University in China and later came to the U.S., and earned three degrees (BA, JD, MBA) simultaneously from Columbia University. After graduation, he worked in an investment bank until 1997, when he founded Himalaya Capital Management, which today manages both LL Investment Partners and Himalaya Capital Ventures, funds focused on publicly traded securities and venture capital. Li Lu was named a global leader for tomorrow by the World Economic Forum in 2001, and a Henry Crown fellow by the Aspen Institute in 1998. He is a member of Council on Foreign Relations and Young Presidents’ Organization.

Fortune: Barnstorm Green

There isn’t a whole lot of information about Lu’s investing style out there. But I thought I would share some notes from a lecture he gave to Columbia Business School back in 2006. All of this is paraphrased, so don’t take anything as a direct quote and there may even be some inaccuracies. Still, I believe you will find these notes insightful, especially with respect to improving your own abilities as an analyst and investor. Even if Lu is not a Berkshire Hathaway CIO candidate, he is an investor with a tremendous work ethic that we could all learn from.

Below are my notes from Lu’s lecture:

Li Lu at Columbia Business School – 2006

-15 years ago, Lu was accidentally brought in to a lecture by Warren Buffett. Had epiphany moment, Lu thought he could do something in the investment business.
-At the time, Lu had just escaped China. Did not know very many people. No money, deep in debt. Worried about making a living in the US.
-In the middle of Buffett speech, made him think differently about the stock market.
-The more Lu thought about it, the more he thought it was something he could do.
-Value investors see themselves as owners of a business. Therefore, fortunes are up and down with the nature of the business.
-You demand a margin of safety.

3 Traits of a Value Investor:

1. Basically, you don’t think of yourself as a paper shuffler who constantly buys and sells securities. You think of yourself as a real owner of the business.
2. You only own a small piece of the business, so you demand a huge margin of safety.
3. Because you think of yourself as an owner, not trading all the time, you think everyone else is different — like Ben Graham’s Mr. Market

On Value Investing

-Under 5% of all assets are run under value investors, a real minority in the investment world.
-The stock market is created for the other 95% of people, that is where your opportunity and challenge is.
-That was one lesson that stuck in Lu’s mind when listening to Buffett’s lecture.
-Biggest challenge: understand whether you are the 5% or the 95%
-It is tempting to do what the other 95% of people do. Emotionally very difficult to be in the 5%, but value investors typically have better returns. The money is really for traders and they tend to amass more assets.
-5% have a spectacular return, but 95% of money probably always resides to somewhere else.
-Understand who you are. You will be tested. You will have to ask yourself whether you are or aren’t a value investor.
-If you are a value investor, you are probably genetically mutated and comfortable being in the minority. This is unnatural to human beings. You have to be comfortable being by yourself. You have to adopt the idea that you are right because your reason and evidence, not because others agree with you.
-You will probably spend most of your time being an academic researcher rather than a professional. You are a researcher or journalist, with insatiable curiosity. You are trying to figure out how everything works.
-The more you know, the better you are as an investor.
-Politics, science, technology, literature, poetry, everything can affect businesses and help you.
-Occasionally you can find insights that will give you tremendous insights that other people don’t have.
-Then you find if the business is cheap. Is the management good? What else? Why is the opportunity there?
-Started fund in late 1997. Been through really traumatic events: Asian Financial Crisis, Tech Bubble.
-Fall of 1998: Lu’s search process is very general. Got hooked on value line, loved to read the whole thing from beginning to end. The best kind of education, you should do this if you want encyclopedic knowledge of companies. Go through it page after page, it is enormously helpful.
-First thing Lu checks is new low list. New low P/Es, P/Bs, etc.
-Does not care where something traded before.
-First looks at valuation. If the valuation doesn’t fit, doesn’t go beyond it.
-If you see a low P/B ratio, ask – What is in the book? How much is the book?
-Encyclopedic knowledge is helpful when looking across different industries.
-Look at pre-tax and pre-interest earnings. Look from an un-leveraged basis. Figure out how much capital is deployed in the business. Look at ROIC.

Example: Timberland

-Start by giving a 5 second look at the business. Timberland. The business is trading around clean book value, consisting mostly of tangible liquid assets, working capital, plus 100M in real estate. Deployed capital is 200M with 100M return.
-Then check why the business fell apart and became cheap. Think if you had owned the entire business at that price.
-At the time, was the height of the Asian Financial Crisis, saw their sales falling off the cliff in Asia. Any thing with exposure to Asia was falling apart. Try to check what other people are thinking about this. You may not listen to their advice but you may want to know what other people are looking at.
-Timberland had no other analysts covering it.
-Why no coverage?
-Look at business across years. Timberland has been growing, pretty profitable, did not need financial markets. Family owned. Owns 40% controlling 98% vote.
-Immediately, that is a turnoff to most people. You can do a quick data search.
-You need to have a curious, active mind to ask questions and find answers.
-Timberland had most of the vote, no analyst coverage, a bunch of shareholder lawsuits. If you were a member of the other 95% of the investment business you might say maybe management is milking the business.
-Download every court document lawsuit. Read it. You NEED a very curious mind to figure out WHAT is happening. Dig every single time. READ EVERYTHING.
-The first time, it takes a couple minutes to look over financials. Then gather questions and do deep research.
-Most lawsuits came from Timberland missing guidance, annoying investors, which annoyed the owner of the business. They decided to stop talking to Wall Street. So it was not about milking the business or fraud. They were not crooks.
-How do you determine if they are good managers? Decent people?
-Act like an investigative journalist. Most business owners leave a trail for you to follow and see how they deal with different situations. Most professional managers would not see this as part of their job, but YOU are part of their 5%.
-Go to their community, visit people they know, their Church, their Synagogue, introduce yourself to their friends and neighbors. It is worth it to spend as much time as possible, to find what these business people have done and what their neighbors say about them to accurately get an idea of their personality.
-The father seemed like a simple, decent guy, just a high school graduate. the son went to business school, was already COO of the company even though he was Lu’s age. Lu saw what boards the son sat on, and noticed that they had a mutual friend. Managed to get himself on the board with the son and became friends quickly. Came to realize these where high quality, very ethical businessmen.
-After all that, saw the stock was still trading low. Decided he did not miss anything. The other 95% may not have done enough research to see this or have some kind of institutional imperative that prevents them from owning.
-If you are not a good analyst, you will never be a good investor.
-But we decide to buy. How much do we buy? Imagine having $900. The other 95% will take tiny positions, 50 basis points. You need to use concentration, a $200 position. Think of how much work you did. Lu visited all the stores to see how margins improved – they had a fad going on where kids wanted the shoes. Their asian business is tiny, reduced earnings by less than 5%.
-Lu put a ton into Timberland. What happened after next 2 years? Stock went up 700%. Propelled by earnings. No real risk – went from trading at 5x earnings to 15x with earnings growing 30% a year. It adds up.

Be a Learning Machine
-When an investment opportunity comes, you have to seize it. Devote day and night so you can act quickly. Do everything complete but do it fast. You have to train yourself to jump on opportunity.
-When opportunity presents itself you can smell it. The only way to do that is by training yourself and reading page after page of financial report.
-Uses S&P manuals for viewing foreign stocks.
-As an owner, don’t think about per share information.
-Use your brain, when looking at stock manuals, each page should really only take 5 minutes. Don’t use calculators. Use mental math.

Example: Korean Company
-60M market cap, pre-tax earnings of 31M, roughly 2x pre-tax earnings.
-Book value of 230M, what constitutes book value? If you are an owner, look at: fixed assets, working capital, don’t count on goodwill.
-Basically you see with 60M in market cap, 30M in pre-tax, $240M in book value ($180M in fixed assets)
-It might be cheap.
-Determine what the earnings is. The book. The working capital.
-Use common sense, common logic and think about the business.
-Most employees never went to business school, Lu finds they are easier to train.
-Of the 70M in current assets, it is all cash
-Of 180M in fixed assets, they own 100% of a hotel, recorded 30M as book. Own 13% of a department store recorded as 30M.
-Look up the department store, it roughly has a market cap of 600M. 13% gives you roughly 80M. So the book value undervalues it by another 50M.
-They own 15% of 3 cable companies and a whole bunch of real estate.
-The department store has exactly the same profile. Trading roughly around cash and investments, good earnings, and own a whole bunch of assets. Turns out they are the second largest cable operator as well
-The department store operates like a hotel, do not take inventory, more like a shopping mall.
-They charge a percentage on the top line of all merchant sales.
-Put it all together: Paying 60M, 70M in net cash, another 100M in stock, 30M in hotel with a value that has not been changed in last 10 years while real estate market has gone up in 10 years. Went to Korea, looked at hotel and department stores.
-Checked recent transaction of properties in neighborhood, value is likely 2-3x what is on the book. But take what is on the book anyway, add 150M. Add that to rest and you get 320M in assets that you are paying 60M for and earning 30M annually from operations.
-Insiders own 50%
-Many factors going in your favor, but you need to look at how local investors see it. They need to be buying it for the price to go up.
-Department store used to trade at 22 went to 100
-This company was at 12 now trades around 70
-each went up 5-6x

Don’t just listen. Do it.

-This type of an approach is not natural to an investor.
-If you decide your personality fits in with the mutated gene pool, that this is something you might be looking to do, there is a lot of money in it — proven by Ben Graham to Buffett
-You have to put in a lot of work into your analysis.
-You can make a lot of money if you are really interested, listening, and actually DOING IT.
-Lu benefited from listening to his value investing class and then actually going out and doing the work required.
-Value investing is not really about theory, it is about what works.
-Young analysts have energy and nothing to lose, so they should go and do the work.
-Before you become a good investor, you need to be a good analyst.

Lu says you need two things to be a good analyst:

1. Provide accurate and complete information. You have to go to an extra length to get it done. Most of the time you will stand alone against everybody else. If you are not competent about what you know, you cannot possibly take conviction positions when things go into free fall and everybody else is laughing at you.

2. Most money is not made in stocks from the examples. They do not provide out-sized returns. You can do the Tweedy Brown/Graham or the Buffett/Munger school. Your returns will come from a handful of stocks. You need tremendous insight by continuous intense curiosity and study.

Investment Mistakes

-Most mistakes come from inaccurate or incomplete information.
-Biggest mistake: most people wanted 2 week or monthly returns. They wanted to go up in down markets.
-Lu’s biggest mistake was straying, was working with Julian Robertson, started shorting — have to think like a trader when you are shorting because your downside can be unlimited. It’s like Charlie Munger says — having your hands tied behind your back while getting into a fight.
-Missed the opportunity to buy a business below cash, even though Lu knew the management and had great insights. The business subsequently went up 50-100x. Could not bring himself to buy it because of his mindset at the time.
-You make a mistake when you have not finished your work but like it enough. You start betting on probabilities instead of real analysis.

Constantly search for ideas

-In your life, you may only have 5-10 key moments of insight. You only get it from continuous learning. Find an American business and then find the Asian counterpart. Some businesses studied for 15 years. You need to know what that business is, how it ticks, so you can swing with conviction. If you cannot do that you will not make huge out-sized returns.
-If you do what Ben Graham or Tweedy Brown does, you will make 15-20% returns but you wont make the huge returns of Buffett.
-The biggest ideas can give 10,000x returns.
-Opportunities are not easy to find. They require a lot of factors to come together – Charlie Munger’s lollapalooza. You need a whole bunch of things working together where you have the insight and are willing to bet.
-This is what drives Lu in business.
-Lu started in physics, mathematics, law, economics, got interested in other subjects. Wife has a PhD in biology, he has learned a lot from her.
-Learn from everything, be intensely curious
-Eventually you will stumble into one big opportunity.
-In the meantime, you will stumble into Timberland style investments which aren’t bad.
-There might be years without opportunities, then years with a lot of opportunities.
-Depends on what becomes available to you.
-They do not come in a steady pace, not like once a week an idea.
-In 6 years, Lu had maybe 3-4 great ideas. But you get progressively better and better, improving the amount of opportunities for you since you will be quicker at your analysis.
-Go through every day by learning something. In a year you have to learn a great deal.
-When Lu reads biology, physics, history, it is all searching for ideas. If one idea jumps out, it is all Lu does. Rest of the time is spent with wife and kids and Lu learns from them too, especially with seeing how human cognition develops which is enormously important.

Li Lu’s Investing Checklist:

1. Is that cheap?
2. Is it a good business?
2. Who is running it?
3. What did I miss?

-Lu goes through the checklist, ‘what did I miss’ is greatly affected by psychology. This kind of cognition happens early on and Lu learns it from interacting with his girls.

Three characteristics of a value investor:

1. Business owner mentality
2. Difference in time horizon
3. Demand a huge margin of safety

Think like a Business Owner

-It all comes from one thing, that you are a business owner. You cannot force management changes, so you demand a margin of safety. You have a long time horizon because you think like an owner.
-But why dabble with stock market? Stock markets are made for people who can dream. That is why 95% of people never buy into value investing. Human nature prevents it.
-You do not belong to the stock market but you have to understand its perspective to position yourself properly. If you are truly think like a business owner, you will eventually leave the asset management business and run a real company. That is why Buffett and Munger left it.
-Or you become a private equity investor.
-The people who the stock market is designed for are fundamentally flawed people. Traders are bound to make mistakes due to fear or greed. They will always make room for value investors.
-Used to be strict about selling with great business. Now, sometimes Lu feels he has insights about the business that allows him to believe the probabilities are in his favor for the business actually improving year after year.
-That is the law of distribution in good businesses. The leaders perform spectacularly well.
-Selling makes you pay a huge amount of tax and you might not get that good buying price again.
-If a business can generate 50-100% ROIC, the mathematics get interesting very quickly.
-Caveat: you have to be very confident. Investment bankers use BS and project into infinity. You cannot project that long. There are only a few opportunities where you can project that long.
-If you are good, and spend your entire lifetime studying, across 50 year career maybe 5-10 opportunities where you can confidently project the next 10-20 years. At that point, you don’t want to sell. By holding you don’t pay the tax on capital gains, so you are really compounding 40% interest free, the business is deploying the capital at 40-100% a year in a tax efficient manner. That is what you do.
-You have to identify businesses that are getting stronger and stronger every year.
-What makes one business more successful than others? Why are they making more and more money compared to others?
-The only way you can find that is by studying the ones that are established.
-Look for great businesses, not just businesses owned by Warren Buffett

Example of a great business: Bloomberg LP

-Product was superior to others, high switching costs
-Bloomberg is a fabulous case study, it came out of no where.
-Gained market share little by little, crossed a milestone point, became a monopoly
-At a certain point, after being highly relied upon for daily work, the switching costs become to high so winner takes all.
-Suppose you have an opportunity to see how an industry evolves early on. At a certain point they cross the line
-Maybe when introduced to all businesses. There is a time when that line gets crossed and a public company is poised to benefit by becoming a monopoly business.
-Why did Microsoft succeed over Apple? Little by little they eroded Apple’s 100% market share.
-Offices were using Windows. Today – do you have a choice of not using Bloomberg?
-Bloomberg visits almost every month and asks what you do, how you use the system. Bloomberg terminals have tens of thousands of functions, they don’t give you a manual
-They want you visually hooked so it is a behavioral connection and you don’t mind paying tens of thousands of years where you don’t have a choice if they raise prices
-They keep coming back to you because they know you are a trader and want to provide you with more services so you are hooked.
-That is why Bloomberg is a fabulous business because you get hooked. Think about switching from that or a competitor coming up with a rival product. How do you compete with that?
-Lu doesn’t know. Suppose you know the inflexion point. Do you want to invest? Lu would invest in Bloomberg at that point.
-You need insight. Study every business. They all have more or less this type of dynamic.
-Your job as a good financial analyst is to study that business ALL THE TIME. Observe those trends.
-Once in your life, maybe you will find that opportunity.
-Why doesn’t Bloomberg want to sell? He doesn’t need to sell.
-When you have a business like that, you don’t need to sell.
-Lu has made many private investments, ex: CapitalIQ, which copies Bloomberg’s business model. Same method with an investment in an engineering service.
-Lu likes to know as much as he can. He likes to be friends with people, with Timberland, the CEO and his son actually became investors in Lu’s fund.
-You can learn and observe from everyday business decisions and learn dynamics.
-Nothing is constant. Everything is changing that is why you have to keep learning.
-Businesses change, Microsoft has threats now.
-You need an active mind, so you are prepared to act and you can seize opportunity due to your insights.

In a previous post, I described my attraction to the theory of deliberate practice. Deliberate practice is an idea popularized by Malcolm Gladwell in his excellent book Outliers (read it — even Charlie Munger recommends it). The idea goes something like this:

When we look at any kind of cognitively complex field — for example, playing chess, writing fiction or being a neurosurgeon — we find that you are unlikely to master it unless you have practiced for 10,000 hours. That’s 20 hours a week for 10 years. The brain takes that long to assimilate all it needs to know to achieve true mastery.

The ’10,000 Hour Rule’ (Bottom Line Secrets)

But sheer hours aren’t enough. You have to ensure that you are putting in a lot of hours of the right type of work. To me, this is where most new investors trip up. Instead of actually analyzing companies, they often become fixated on celebrity-investor navel gazing. What I mean is, instead of going out and finding undervalued companies, they spend most of their time reading about what famous investors are doing. They have no real knowledge of the companies they invest in aside from the fact that someone famous has a stake in the company. You become the equivalent of a chicken running around with your head cut off. The other problem I saw was that some investors merely advocated the daily reading of a 10k. This kind of practice does not yield much if you are not able to connect what you read with the company and the industry they inhabit.

Recently, Cal Newport used Dr. James McLurkin as an example for how to become a star in your field by using deliberate practice:

In 2008, when James McLurkin graduated with a PhD in Computer Science from MIT, he was unquestionably a star. Four years earlier, Time Magazine profiled James and his research on swarm robotics as part of theirInnovators series. The next year, he was featured on an episode of NovaScienceNOW. The producer of the show, WGBH in Boston, built an interactive web site dedicated to James, where, among other activities, you can watch a photo slide show of his life and find out what he carries in his backpack. Earlier this year, TheGrio, a popular African American-focused news portal, named James one of their 100 History Makers in the Making — a list that also includes Oprah Winfrey and Newark, NJ mayor Cory Booker…

“Every semester, my supervisor, Anita [Flynn], had me write out goals,” James told me. “We would go back at the end of the semester and look at what I did and didn’t do. She would tell me, ‘it’s fine that you didn’t get this all done, but what’s not fine is your inability to estimate how long something will take.’”

James describes this lesson as perhaps the most valuable he learned as an undergrad at MIT. Under the tutelage of his supervisor, he honed his ability to choose projects that were hard enough to stretch his ability, but still reasonable enough that he could complete them. She wanted him to be ambitious and set big goals, but she had no tolerance for goals so big that they were beyond his ability to finish in a reasonable time frame.

How to Become a Star Grad Student: James McLurkin and the Power of Stretch Churn (Study Hacks)

Newport calls this stretch churn:

With this in mind, I argue that the secret to James McLurkin’s success is his ability to choose the right projects. By resisting work that reinforced what he’s comfortable with, yet also sidestepping overly-ambitious projects, he consistently advanced his skill until he arrived at the bleeding edge of research robotics. Once there, the “breakthrough” projects that cemented his reputation became obvious next steps.

Put another way: stretch projects are an effective way to integrate deliberate practice into fields without clear competitive structures and coaching. If you’re a figure skater, a top coach can walk you through the hard jumps you need to get better. If you’re a grad student (or entrepreneur, writer, or knowledge worker), however, there are no such coaches to guide you through this process.

Stretch projects can fill this role.

To make this more concrete, let me give you a couple definitions:

Stretch Project: A project that requires a skill you don’t have at the outset.
Stretch Churn: The number of stretch projects you complete per unit of time.

How to Become a Star Grad Student: James McLurkin and the Power of Stretch Churn (Study Hacks)

I believe stretch projects and stretch churn can be implemented by those of us hoping to improve our abilities as investors. We often hear Warren Buffett talk about circles of competence and having a ‘too hard pile’ for investments. The problem is, some investors hide behind these ideas and in turn, limit their ability to improve as investors.

I want to outline some of the steps I’ve taken and actually implemented in order to improve my abilities as an analyst.

1. Seek out peers and mentors

James McLurkin benefited from working in MIT’s robotics lab with people who were more experienced researchers. Advisers like Anita Flynn were able to provide the kind of feedback and guidance that he needed for self-improving.

I’ve also sought out mentors. What I try to do is find investors from diverse backgrounds with differing amounts of experience and viewpoints. You must be open to different perspectives when it comes to investing because bias is your worst enemy. Finding people with an expertise in an area you are trying to master is always helpful. For instance, starting in the summer of 2009, one of my goals became improving as a financials analyst. During the crisis I had no luck with analyzing banks, I defaulted and claimed they were in my ‘too hard pile’ or out of my circle of competence. But I wanted to get better. I now know four different analysts that have a speciality in financials, with their help, I can start analyzing a company and then converse with them on whether my thought process is correct. They have also in turn, helped my by teaching me their different approaches to analyzing banks.

The result? I’ve become comfortable with looking at banks. I can’t say I am confident in a valuation for something like Citigroup, but I can analyze smaller, more community-focused banks. I’ve completed write ups and valuation models on four different banks so far.

Beyond that, I’ve also made contact with peers/mentors that specialize in everything from global value investing to special situations. Whenever I am looking at a situation that fits into one of their specialties, I can run it by them to get constructive criticism.

2. Increase your skills (stretch projects)

McLurkin figured out how to expand his knowledge by setting goals that would stretch and increase his knowledge. For me, this means striving to analyze and value companies with business models I’ve never encountered before.

For example, as many of you know, I enjoy looking at spinoffs. They are my favorite type of special situation. One spinoff that I analyzed a couple of months ago was Madison Square Garden (NASDAQ:MSG). Madison Square Garden is a company that might be daunting to value at first. There is no readily available comp for the company. With three different operations (sports, television networks, and entertainment) you must to take a sum of the parts approach when valuing it. From there, each part could be valued by more traditional methods, e.g.: the television network might be an EBITDA multiple or the sports franchise value might be determined using recent transactions. For me though, MSG was made up of three different businesses that I had never valued before. The benefits of that experience were tremendous. Now, I can apply some of those same principles when looking at companies that are tangentially connected. As an example: the methods for valuing MSG’s television business might be applicable when valuing Liberty Media Starz, a premium cable TV network.

To me, the more types of companies you can value, the more opportunities you can have. By being a generalist, you can look at practically anything. You should strive to be a generalist because there are times when one sector or another becomes overvalued. If you strictly stick within that domain, you need to be extremely disciplined in your approach. What I have seen is that most investors end up lowering their standards so they can remain active. Or, they over estimate their expertise – Wall Street is a great cautionary tale for this, for all their sector specific expertise, they missed the crisis.

3. Pick projects that you can complete (stretch churn)

With Anita Flynn’s advising, McLurkin picked projects that would not only stretch his ability, but also get completed on time. Setting goals and then accomplishing them creates a motivation loop that keeps you going.

At the moment I have a spreadsheet in Google Docs that contains my watch list of 90+ stocks. Why 90+ stocks? In my research on Michael Burry, I was really taken back by his drive for valuing companies. I remember that he had a watch list of 80 businesses that he would buy at specific prices. In light of the most recent crisis, I didn’t do much buying. I actually made just one investment. If I had a watch list of 90 companies that I knew really well, I believe I would have been able to profit to a greater degree from the market’s draw down.

Part of my goal with using deliberate practice is to value all 90 companies on the list and expand my circle of competence as much as possible with it. In order to get through so many companies in a reasonable amount of time, say 2-3 per week, I tend to gravitate towards smaller businesses. They have fewer moving parts and are easier to analyze (for more on analyzing nano-caps, read my interview with Paul Sonkin) than large conglomerates, but offer varying business models. Value can be anywhere, so you don’t have to strictly look at nano/microcaps, but they make wonderful starting points.

More practically, it might take you an entire month to really master your analysis of General Electric. The trade off is that during that month, you may have been able to learn 8 different nano-caps. You’re better off working on those 8 because you increase your chances of finding an undervalued company. I’d rather know the value of 90 companies than 12 because it expands my hunting ground for profitable opportunities.

In the last 30 days, I can say that I have somewhat met my weekly goal. I’ve valued about 10 companies which is within my ideal range of 8-12. When I mean I’ve valued them, I don’t simply mean that I have opened their latest 10K, pulled an earnings figure, and slapped a multiple on them.

5 of the companies valued over the last 30 days were in the same industry. I had to go back about 6 years and collect data to see how they traded at different points in the capital cycle (they are cyclical), furthermore, I spoke to the management teams at two of them. Two of the companies were nano-caps, where I spoke not only to management but also customers and competitors. With nano-caps, this kind of approach is key because they often have significant customers as a percentage of revenues. The loss of one can be devastating to the business. You must get comfortable with their abilities as businessmen and I think the scuttlebutt approach works extremely well for this. One company was in a sector where I had little expertise, but where I had analysts as friends. I tapped their knowledge for valuing the company and learned a lot.

To deviate, the last two companies were special situations. These are a bit different because the past is rarely a good predictor of the future, with special situations you are often analyzing the intricacies of a transaction. Often, in something like a spinoff, when you do the pro-forma analysis you might find you can buy the parent and get the spinoff for free. Much of the analysis comes down to seeing how much one share of the parent gives you of the spinoff and then separate analyses on the two different businesses. These can require more work on your behalf, since you are valuing two companies, but the rewards are wonderful. What’s great is as you go through more and more of these transactions, you pick up a lot of knowledge about the granular transaction details which makes looking at the next situation less complicated. Plus, Special situations can help give value investors investments that have clearly defined catalysts in place and can sometimes be market neutral. Two qualities that are helpful in choppy markets.

So far I’ve been really pleased with my progress through my watch list. I don’t want to say that the list is my only source of investment ideas, I still look every day for new ideas, which is why the list is hovering over 90. But, I have found it useful for formalizing my learning process with clearly defined goals in place. For newer investors hoping to improve their abilities as analysts, this formal approach to practicing is probably better than looking at 13F filings all day.

My friend Miguel Barbosa has an excellent interview with James Montier (of GMO and author of: Value Investing: Tools and Techniques for Intelligent Investment). I thought I would give you a couple of excerpts, I believe the whole interview is worth reading and suggest you do so. Miguel tells me that he should have his second part up soon.

A few days ago, when discussing value investing, a friend asked me why value investing does not stop working. Value investing thrives because of certain inefficiencies in the market and it has been written about for more than 70 years now. So why doesn’t the market catch on? Montier provides us with an answer:

Miguel: Tell us about the price = quality heuristic? Why do investors overpay for beauty and underpay for toads…after all they are one step away from becoming princes are they not? This heuristic complements the Anginer et all study where ugly defendants are more likely to be found guilty and receive longer sentences than attractive defendants.

James Montier: We humans have a bizarre bias against a bargain. For instance, my friend Dan Ariely has done some great experiments in this field showing some pretty odd findings. Imagine you taste two glasses of wine one you are told comes from a $10 bottle, the other comes from a $90 bottle. You will almost certainly say that the $90 wine tastes much better. The only snag is that the two wines are exactly the same. So never come to dinner at my house, because I’ll give $10 wine, and tell you it costs $90!

The same thing happens with pain killers. It is why branded pain killers exist alongside generic equivalents. They both have exactly the same active ingredient, but people report the branded version works better.

I suspect that something similar happens with stocks. Stocks are the one thing we don’t like to see on sale. So a ‘cheap’ stock must have something wrong with it, and an ‘expensive’ stock must be a sign of quality – at least that’s the way we tend to view things.

The Anginer et al study shows some similar findings in the legal context. Ugly defendants get far worse sentences, than attractive defendants. We have a hard time believing that attractive people could have been bad – a kind of halo effect, if you will.

If you haven’t already, I really suggest you read Dan Ariely’s book Predictably Irrational, it is one of my favorites. Montier gets at why I think markets wont figure out value investing — the participants are too irrational. Usually, what you will see are investors who claim to practice value investing, only to abandon it when things get tough. It is a style of investing that requires levelheadedness, courage, and patience, which many investors lack.

One of the topics Montier touches on is short selling, which I thought was pretty interesting. Most value investors don’t short, so it is always nice to take a look at the ones who do:

Miguel: Tell us about the folly of using price to sales as a proxy for value.

James Montier: Price to sales is fine if you are looking for short candidates, but as a long side value criteria it makes no sense to be at all. After all as long as you promise to value me on price to sales, I’ll set up a business selling $20 bills for $19…I’ll never make a profit, but if you are looking at price to sales you won’t care.

Price to sales is typical of the drift up the income statement when the bottom line gets too demanding. If your PE starts to look expensive, get everyone to look at a less demanding metric, enter stage left price to sales. If that starts to look tough, abandon the income statement and look at the value based on eyeballs and clicks!

Miguel: What I enjoy about your writing is that you aren’t afraid to talk about “controversial topics” – yes I’m talking about your work on short selling. Can you quickly tell us what you have learned about short sellers (their characteristics, screens, etc).

James Montier: Short sellers are everyone’s favorite scapegoats. They make money when things go ‘wrong’. Of course, what the authorities forget is that simply because a short seller sells a stock, doesn’t mean it goes down – if only it were that easy we’d all be short sellers. As David Einhorn observed, I’m not critical because I’m short, I’m short because I‘m critical.

In my experience, short sellers are amongst the most fundamental investors you’ll come across. They understand the ins and outs of a business better than just about everyone else. They are highly skilled at figuring out poor economics when they see if. They act as acting police, helping to uncover fraud – something that the regulators used to do (a very long time ago).

My own work on short selling has focused on a number of areas. In general, shorts tend to come into a couple of categories: bad businesses (i.e. poor economics), bad accounting (obvious), bad management (the guys at the top haven’t got a clue). In addition I often look for several traits, such as expensive, unrealistic growth expectations, too much debt, and poor capital discipline (i.e. needless and tangential M&A).

I also created a measure called the C-score (C is for cheating or cooking the books). It aims to look for the quantitative red flags which often accompany bad accounting.

Excerpt: Details of the C score Page 263 of Value Investing Tools & Techniques for Intelligent Investment

1. A growing difference between net income and cash flow from operations.
2. Day sales outstanding is increasing.
3. Growing days sales of inventory
4. Increasing other current assets to revenues.
5. Declines in depreciation relative to gross property plant and equipment.
6. High total asset growth.

Miguel Barbosa interviews James Montier (Simoleon Sense)

Those are just two questions that Montier answered. There are many more over at Simoleon Sense and I highly recommend the interview.

Meridee A. Moore runs Watershed Asset Management, a $2B hedge fund in San Francisco. She gave the NYTimes an interview on management, and I thought the following test she gives analysts is pretty interesting:

Q. What are some other screens?

A. We give people a two-hour test. We try to simulate a real office experience by giving them an investment idea and the raw material, the annual report, some documents, and then we tell them where the securities prices are. We say: “Here’s a calculator, a pencil and a sandwich. We’ll be back in two hours.” If an analyst comes in there and just attacks the project with relish, that’s a good sign.

Q. Is this one of those impossible tests, where you’re asking them to do seven hours of work in two hours?

A. Yes. But you’d be amazed at how well people do. After two hours, two of us go in and just let the person talk about what he’s done. The nice thing about my being trained as a lawyer, and never going to business school, is that I’m able to ask the basic, financially naïve questions, like: “What does the company do? How do they make money? Who are their customers? What do they make? How do they produce it?” That throws some people off.

Q. Really?

A. Often, analysts go right to the financials and forget to think about the company’s business model. If the person avoids answering the basic questions and instead changes the subject to talk about the work they did, that tells me the person is a bit rigid. Instead of trying to respond to what’s being asked, they’re trying to get an A on the test.

Also, if they’re a little too worried about pleasing me, that’s not good, either, because it’s not a please-the-boss competition. The point of the exercise is to make sure that we’ve thought about the issues critically, so we are in a position to make a good investment decision.

The other quality we look for is whether the person can distill a lot of very complicated information down to its essence. Can you figure out the three or four issues that are most important for understanding this investment? Or do you get distracted by aspects of the company that really have nothing to do with making an investment or determining value?

An Office? She’ll Pass on That (NY Times)

This is kind of funny for me. It sounds stupid, but when I decide to look at a company, my first task is to scribble “How they make money: …” and use that to shape the rest of my analysis. I’ve found I often make mistakes when I try to tackle things from a purely financial perspective and it helps to take a step back and look at how to business works and then see how that translates into its financials.

Hunt Alcott, a behavioral economist with MIT, talks about improving consumer decision making when it comes to making better choices regarding energy usage. I thought it was pretty interesting that he cites Robert Cialdini’s work in psychology. As you know, Cialdini’s book Influence: The Psychology of Persuasion is one of Charlie Munger’s favorites:

Q. To what extent will consumers make different choices if they simply have the facts about energy explained to them in a clear manner?

A. The effect of clearer information is an empirical question that often has surprising answers. One example of this is from OPOWER, a company that our research group interacts with a lot. OPOWER sends home energy use reports to households that compare those households to their neighbors and give energy conservation tips. The information in these reports is very similar to what’s already on a utility bill: How much did you spend this month, how much did you spend this year, here’s where you can get compact fluorescent lightbulbs. But something about the way they’re presenting it — presumably the way they use comparisons to neighbors — seems to be very powerful. I’m not sure it would have been obvious to any of us 10 years ago or three years ago that this program would have large effects in the real world.

There was an academic study by psychologist Bob Cialdini and co-authors that helped provide the proof-of-concept for the OPOWER program. In this study, the researchers left door-hangers at a group of households in California. Some of the door-hangers said, “Save money by saving energy,” some of them said, “Save the environment,” and some said, “Here’s how much your neighbors are using.” And the ones that said, “Here’s how much your neighbors are using” had a much stronger impact on energy consumption. In the last couple of years that study in particular has had a lot of influence.

Q. Okay, so why is it that referring to neighbors is effective?

A. Psychologists have been great at documenting that if you tell people what the social norm is, people will converge to the social norm. In my mind there are two leading economic hypotheses for why this works in energy consumption. One is called “conditional cooperation.” People may be altruistic, and they view conserving energy as contributing to the public good of reducing climate change. People are typically more willing to contribute to a public good if they are informed that other people are contributing more than they are.

The other explanation is just social inference. It could be that I couldn’t care less about the environment, but I do want to save money. And if you tell me that I’m using twice as much energy as my neighbor, that lets me know that maybe I’ve been leaving a window open or that my furnace is inefficient. So that’s purely a self-interested, informational story. Testing between these two explanations is one of the research questions we’re interested in.

3 Questions: Hunt Alcott on behavioral economics and the energy crisis (MIT)

This is a real gem:

But I was mistaken. There was never a prize in the lot. I could read of railway accidents every day — the newspaper atmosphere was foggy with them; but somehow they never came my way. I found I had spent a good deal of money in the accident business, and had nothing to show for it. My suspicions were aroused, and I began to hunt around for somebody that had won in this lottery. I found plenty of people who had invested, but not an individual that had ever had an accident or made a cent. I stopped buying accident tickets and went to ciphering. The result was astounding. ‘THE PERIL LAY NOT IN TRAVELLING, BUT IN STAYING AT HOME .

I hunted up statistics, and was amazed to find that after all the glaring newspaper headings concerning railroad disasters, less than three hundred people had really lost their lives by those disasters in the preceding twelve months. The Erie road was set down as the most murderous in the list. It had killed forty-six — or twenty-six, I do not exactly remember which, but I know the number was double that of any other road. But the fact straightway suggested itself that the Erie was an immensely long road, and did more business than any other line in the country; so the double number of killed ceased to be matter for surprise.

By further figuring, it appeared that between New York and Rochester the Erie ran eight passenger trains each way every day — sixteen altogether; and carried a daily average of 6,000 persons. That is about a million in six months — the population of New York city. Well, the Erie kills from thirteen to twenty-three persons out of its million in six months; and in the same time 13,000 of New York’s million die in their beds! My flesh crept, my hair stood on end. “This is appalling!” I said. “The danger isn’t in travelling by rail, but in trusting to those deadly beds. I will never sleep in a bed again.”

(Mark Twain Quotes)

Most people fixate on interesting accidents over frequent accidents. This often causes sensationalist reporting and people start to fear a shark attack over crashing into a deer, even though the latter is 300 times more likely to occur.

For investors there are some take aways too. If you talk to an ordinary person about what they are interested in investing in, you are likely to be disappointed. Most would rather have the thrill and excitement in investing in what everyone thinks will be the next big thing. But if you look at the evidence from the past, these investments are usually almost always failures. The powers of creative destruction almost always ensure that new industries are rife with failures as businessmen gradually figure out the right economics. Instead, You are much better off looking at industries that have withstood the test of time and are trading at undervalued levels.

(Flickr: Mikey G Ottawa)

Drake Bennett at the Boston Globe has an interesting article on cognitive fluency. Basically, he cites research that says the more simple or familiar something is, the more persuasive it becomes:

One of the hottest topics in psychology today is something called “cognitive fluency.” Cognitive fluency is simply a measure of how easy it is to think about something, and it turns out that people prefer things that are easy to think about to those that are hard. On the face of it, it’s a rather intuitive idea. But psychologists are only beginning to uncover the surprising extent to which fluency guides our thinking, and in situations where we have no idea it is at work.

Psychologists have determined, for example, that shares in companies with easy-to-pronounce names do indeed significantly outperform those with hard-to-pronounce names. Other studies have shown that when presenting people with a factual statement, manipulations that make the statement easier to mentally process – even totally nonsubstantive changes like writing it in a cleaner font or making it rhyme or simply repeating it – can alter people’s judgment of the truth of the statement, along with their evaluation of the intelligence of the statement’s author and their confidence in their own judgments and abilities. Similar manipulations can get subjects to be more forgiving, more adventurous, and more open about their personal shortcomings.

Because it shapes our thinking in so many ways, fluency is implicated in decisions about everything from the products we buy to the people we find attractive to the candidates we vote for – in short, in any situation where we weigh information. It’s a key part of the puzzle of how feelings like attraction and belief and suspicion work, and what researchers are learning about fluency has ramifications for anyone interested in eliciting those emotions.

“Every purchase you make, every interaction you have, every judgment you make can be put along a continuum from fluent to disfluent,” says Adam Alter, a psychologist at the New York University Stern School who co-wrote the paper on fluency and stock prices. “If you can understand how fluency influences judgment, you can understand many, many, many different kinds of judgments better than we do at the moment.”

Easy = True (Boston.com)

I can definitely see the use of rhymes and folksy/familiar manners of speaking increase the persuasiveness of your writing. If someone is writing in a very complicated manner, filled with jargon, the reader should be more focused and scrutinizing than if they were presented with a simple letter between friends. Note how Warren Buffett speaks in his letters.

For investors, understanding cognitive fluency could be helpful. I don’t know if I buy the companies with easy to pronounce names argument, but I do believe strong brands are helpful. Companies that are able to evoke familiar images and feelings may have a strong affect on consumers. This could be similar to Warren Buffett’s ideas about how See’s Candies manages to do so well on Valentine’s Day sales.

Read the full article for more details.

This week’s New Yorker has a great article (New Yorker digital subscribers click here) by Malcolm Gladwell on entrepreneurship. Gladwell finds that entrepreneurs are actually not the high octane risk-takers that they are made out to be. Instead, successful entrepreneurs are highly rational actors, akin to predators who follow systemized patterns and go after safe prey. The article prominently features John Paulson’s CDS trade but also refers to a number of other fascinated entrepreneurs like Sam Walton and Ted Turner. While the article wont be available online for a while, I thought I’d quote some excerpts that I feel are worthy of discussion.

At 24 years old, Ted Turner became the CEO of his family’s outdoor advertising business after his father committed suicide. The business was actually quite good and threw off a lot of cash while requiring little by way of capital expenditures.

Turner sought to expand his empire and went after WJRJ, a UHF TV station that was down on its luck:

It was housed in a run-down cinderblock building near a funeral home, leading to the joke that it was at death’s door. The equipment was falling apart. The staff was incompetent. It had no decent programming to speak of, and it was losing more than half a million dollars a year. Turner’s lawyer, Tench Coxe, and his accountant, Irwin Mazo, were firmly opposed to the idea… The purchase price of WJRJ was 2.5 million. Similar properties in that era went for many times that, and Turner paid with a stock swap engineered in such a way that he didn’t have to put a penny down.

Most successful dealmakers that have built real empires all have the ability to find deals with great tax treatments. The Pritzkers of Chicago, John Malone of Liberty Media, and Sam Zell have all sought out these types of deals. Turner also recognized these benefits:

WJRJ’s losses could be used to offset the taxes on the profits of Turner’s billboard business. The television station, furthermore, fit very nicely into his existing business. Turner was very experienced at ad-selling. WJRJ may have been a virtual unknown in the Atlanta market, but Turner had billboards all over the city that were blank about fifteen per cent of the time. He could advertise his new station for free.

Most of these entrepreneurs use these deals to pick up NOLs at low prices which drastically reduce the taxes paid by the businesses they run. These boost profitability and gives them an advantage over competitors. Gladwell also seeks out academic research on entrepreneurship, in order to find patterns that are displayed my large groups of successful businessmen.

First, he cites the work of Michel Villette and Catherine Vuillermot (From Predators to Icons). One of the things that Villette and Vuillermot find is that most successful entrepreneurs are not one-hit wonders. Instead, they find some kind of inefficiency in the business landscape and actively exploit it:

There is almost always, they conclude, a moment of great capital accumulation — a particular transaction that catapults him into prominence. The entrepreneur has access to that deal by virtue of occupying a “structural hole,” a niche that gives him a unique perspective on a particular market.

Villette and Vuillermot go on, “The businessman looks for partners to a transaction who do not have the same definition as he of the value of the goods exchanged, that is, who undervalue what they buy from him in comparison to his own evaluation.” He moves decisively. He repeats the good deal over and over again, until the opportunity closes, and — most crucially — his focus throughout that sequence is on hedging his bets and minimizing his chances of failure. The truly successful businessman, is anything but a risk-taker. He is a predator, and predators seek to incur the least risk possible while hunting.

If you take a moment to think about businessmen and investors who have had extraordinary success, they all seem to exhibit this trait. Most great businesses occupy a space in their industry where they are protected by the wide moat of their competitive advantages. Usually, it is a result of growing and growing until you almost monopolize your sector.

John D. Rockefeller saw an inefficiency in the oil refinery market and quickly moved. He realized that by securing rates with the railroad companies, he could at least gain a cost advantage over competitors. He also realized the economies of scale that could be had by acquiring competitors. At the time, running an oil refinery was a terrible business, many became bankrupt. But Rockfeller was able to build Standard Oil with acquisition after acquisition and emerge with a monopoly.

Sam Walton saw that rural communities were not being served by large discount retailers such as Kmart. He didn’t just open one Walmart, he opened many, using airplane flyovers to find untapped markets that would also connect advantageously with Walmart’s supply-chain system. Walmart grew so large that competitors from urban areas were unable to penetrate his geographic foothold. Walmart was then able to enter urban markets with ease and topple competitors to become America’s most successful retailer.

Ray Kroc saw a market for America’s first nationwide fast-food chain as he sold milkshake machines around the country. What he found were great hamburger restaurants run by people with no entrepreneurial drive behind them to actually franchise them. After encountering McDonald’s in 1954, Ray Kroc sealed a deal to become the company’s sole franchisee and grew the hamburger chain outside of Arizona and California. Today, McDonald’s is the world’s biggest hamburger chain.

While Gladwell refers to John Paulson as an investor who has exhibited these traits recently, Sardar Biglari may be a better example. Biglari started his hedge fund using money from a tech company that he started and sold while in college. He then went on to one by one, target fast-food companies that had high concentrations of company-owned restaurants on their balance sheets. Many of these chains were quite old so it was likely that the real estate, recorded at a cost on the balance sheet, was dramatically undervalued relative to their current market values. All together, Biglari targeted five restaurant chains: Western Sizzlin, Friendly’s, Applebee’s, the Steak ‘N Shake Company, and Jack in the Box. Biglari was able to get on the boards and take control of both Western Sizzlin and Steak ‘N Shake, eventually merging the two. Applebee’s and Friendly’s were both bought out by other companies. Biglari’s least successful attempt was with Jack in the Box, but since he only agreed to exchange shares of Western Sizzlin for Jack in the Box, the cost was virtually nothing.

The other thing Gladwell finds is that most entrepreneurs are able to find inventive ways of financing their business ventures:

Giovanni Agnelli, the founder of Fiat, financed his young company with the money of investors — who were “subsequently excluded from the company by a maneuver by Agnelli,” the authors point out. Bernard Arnault took over the Bousac group at a personal cost of forty million francs, which was a “fraction of the immediate resale value of the assets.” The French industrialist Vincent Bollore “took charge of the failing family company for almost nothing with other people’s money.” George Estman, the founder of Kodak, shifted the financial risk of his new enterprise to his family and to his wealthy friend Henry Strong.

For the entrepreneur, cheap and secure financing can drastically improve the chances of an enterprise’s survival. By investing little of his own money, the entrepreneur can amplify returns on his own invested capital while keeping dry powder in reserve for new opportunities. Most successful real estate developers exhibit the same trait as do private equity firms, little equity is actually invested in the properties acquired in favor of debt. This often leaves the newly privatized properties in danger of default in the case of a sudden economic downturn, while keeping the fortunes of the owners largely in tact.

Gladwell emphasizes the fact that Ted Turner was also averse to using cash in his acquisitions. He explains by using Turner’s purchase of the Atlanta Braves as a case:

The team was losing a million dollars a year, and the owners wanted ten million dollars to sell…

He talked the Braves into taking a million down, and then the rest over eight or so years. Second, he didn’t end up paying the million down. Somewhat mysteriously, Turner reports that he found a million dollars on the team’s books — money the previous owners somehow didn’t realize they had… He now owed nine million dollars. But Turner had already been paying the Braves six hundred thousand dollars a year for the rights to broadcast sixty of the team’s games. What the deal consisted of, then, was his paying an additional six hundred thousand dollars or so a year, for eight years: in return, he would get the rights to all a hundred and sixty-two of the team’s games, plus the team himself…

Turner is a cold-blooded bargainer who could find a million dollars in someone’s back pocket that the person didn’t know he had.

Many successful businessmen and investors seek out hidden assets when doing acquisitions. Often, the value of assets are sometimes obscured by accounting or the market climate. One of Warren Buffett’s most famous investments was in the Sanborn Map company. In 1961 the stock made up 35% of his partnership’s assets and gave him a spot on the company’s board. Astonishingly, while Sanborn sold for $45 per share on the market, the company had an investment portfolio of more than $65 per share. At the time, a buyer of Sanborn stock received an undervalued investment portfolio and a map business thrown in for free.

Using research from economist Scott Shane, Gladwell delves into the notion that the entrepreneur is a risk taker and gives reasons for why entrepreneurs fail:

…many entrepreneurs take plenty of risks — but those are generally the failed entrepreneurs, not the success stories. The failures violate all kinds of established principles of new-business formation. New-business success is clearly correlated with the size of initial capitalization. But failed entrepreneurs tend to be wildly undercapitalized. The data show that organizing as a corporation is best. But failed entrepreneurs tend to organize as sole proprietorships. Writing a business plan is a must; failed entrepreneurs rarely take that step. Taking over an existing business is always the best bet; failed entrepreneurs prefer to start from scratch. Ninety per cent of the fastest-growing companies in the country sell to other businesses; failed entrepreneurs try selling to consumers, and, rather than serving customers that other businesses have missed, they chase the same people as their competitors do. The list goes on: they undermine marketing; they don’t understand the importance of financial controls; they try to compete on price. Shane concedes that some of these risks are unavoidable: would-be entrepreneurs take them because they have no choice. But a good many of these risks reflect a lack of preparation or foresight.

Some of the reasons for failure may seem counterintuitive to a person who is seeking to start their own business. Many may balk at the prospect of taking over an existing business, but if it is a forced sale due to owner’s health or a decision to retire, a budding entrepreneur may have the opportunity to acquire a good business at a low price. This kind of thinking requires the entrepreneur to employ the kind of rational judgment that is totally counter to the cowboy image the media perpetuates.

Another of these traits is not caring what other people think. Gladwell notes that many successful entrepreneurs are willing to risk their personal reputation for their business. He contrasts the behavior of banking CEOs who kept piling up bad investments because they feared standing out from the crowd with Sam Walton’s decision to seek financing from his in-laws a second time after failing at his first venture:

Villette and Vuillermot point out that the predator is often quite happy to put his reputation on the line in pursuit of the sure thing…

If an awkward family reunion was the price Walton had to pay for a guaranteed line of credit, then so be it. He went out of his way to take a personal risk in order to avoid a professional risk. Reputation, after all, is a commodity that trades in the marketplace at a significant and often excessive premium. The predator shorts the dancers, and goes long on the wallflowers.

If there is one thing that is really representative of the entrepreneurial stereotype, it is the unflinching persistence that seems to be exhibited by all the examples used in the article. Gladwell ends with a story about the lengths Turner went to, to take back his family’s outdoor advertising business:

He hired away the General Outdoor leasing department. He began “jumping” the company’s leases– that is, persuading the people who owned the real estate on which the General Outdoor billboards sat to cancel the leases and sign up with Turner Advertising. Then he flew to Palm Springs and strong-armed Naegele into giving back the business…

Naegele, by the way, asked for two hundred thousand dollars, which Turner didn’t have. But Turner realized that for some o ne in Naegele’s tax bracket a flat payment like that made no sense. He countered with two hundred thousand dollars in Turner’s Advertising stock…

“I had kept the company out of Naegele’s hands and it didn’t cost me a single dollar of cash.” Of course it didn’t. He’s a predator. Why on earth would he take a risk like that?

Here, Turner really serves as an example for all entrepreneurs. His father had sold General Outdoor and committed suicide shortly afterwards. Such an event must have been emotionally jarring for someone like Turner, but he managed not to be constrained by grief and moved into action. All of his decisions, from poaching personnel to exploiting his adversary’s tax status exemplified the kind of clear-sightedness that is necessary for long-term entrepreneurial success. For the entrepreneur and investor, being able to keep calm emotionally is an absolute need when faced with the daily competitive pressures and changing landscape of the market.

The entire article is worth the read, I would suggest seeking out a copy from your news stand or purchasing a digital subscription, these excerpts are just a small part of it. This is especially true if you are interested in John Paulson. Gladwell dedicates a large part of the article to discussing how and why Paulson managed to earn billions of dollars by purchasing credit default swaps.