Street Capitalist: Event Driven Value Investments

One of the issues with Street Capitalist is that I don’t think take the time to really introduce new readers to value investing. This can be problematic with someone who is just learning about all of this and feels daunted by the task of somehow soaking it all up. I plan on doing some how-to’s in the future to help with this. For now though, I want to show you some investment cartoons I found from at Mirae Asset Financial Group.

Mirae is run by an investor named Park Hyeon Joo of Korea. I’m always fascinated at finding and learning about value investors who operate in different parts of the world - especially in Asia. Asia in particular is an interesting place for value or even long term investors. Mainly because the region as a whole has a reputation for overwhelmingly favoring short-term investing.

Here’s an excerpt from a Bloomberg article on Park:

The new firm caused a small stir in the business press because its offices didn’t include the wall-sized electronic stock ticker that graces most Korean brokerage offices. In his book, Park says his message to customers was: “Don’t sit around staring at the wall. Let professionals do your investing.” He reeled in clients by lowering the standard fee for stock purchases to 0.029 percent from 1 percent.

In a similar symbolic gesture, Park placed a clock with no hands at the entrance to Mirae Group’s Seoul headquarters — to signify to clients the importance of long-term investment.

Korea’s No. 1 Money Manager Says Genghis Khan Model for Funds (Bloomberg)

The Power of Inactivity

I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.
- Warren Buffett

Circle of Competence

We don’t handle high-tech business because we have no talent in that area.
- Charlie Munger
There are all kinds of businesses that Charlie and I don’t understand, but that doesn’t cause us to stay up at night. It just means we go on to the next one, and that’s what the individual investor should do.
- Warren Buffett

Contrarianism

Invest at the point of maximum pessimism.
-John Templeton

We invest in stocks because stocks are plunging. Since we can buy stocks at a low rate in a bull market, I am nervous in a bull market. When stock market plunges, I’m happy. Crisis is a good opportunity. I know that more opportunities happen when business is dull and disaster & revolution break out.
-Mark Mobius

The quotes may not be anything new, but it’s nice to see the visual representations of these concepts, even in cartoons. They give you a simple way of conveying some often complex and hard to understand concepts and they’re pretty fun.

News stories are already circulating about the poor performance of certain hedge funds (quite a few within the “value” group). While my portfolio is largely concentrated in Fairfax Financial (FFH), its performance has still fallen from its highs and one of my newer positions – Air Transport Services Group (ATSG) is almost 50% lower than my initial position. It is times like these that an investor’s fortitude is really tested and Jason Zweig’s latest Intelligent Investor column How to Control Your Fears In a Fearsome Market (WSJ) provides a solution for us.

Zweig points out that seeing your investments fall actually triggers a neurological response by your brain:

Merely reading the words “market crash” in this sentence can instantaneously jack up your pulse and your blood pressure, the output of your sweat glands and the tension in your muscles. Stress hormones will flood your bloodstream. Your eyes will widen and your nostrils flare, making you hypersensitive to any further danger. All this occurs automatically, involuntarily and unconsciously. You can’t be an intelligent investor if, without even knowing it, you are thinking with the panic button in your brain.

The good news is that these feelings can be controlled. Zweig outlines four steps for controlling your fears. He says first, we need to:

Reappraise. Forget what you paid for that stock or fund; instead, imagine it was a gift. Now that it is priced, say, 20% more cheaply than in December, should you want to return the gift?

I try to use the reappraisal method often. You need to really write out your thesis for investing in a company so that you can test it against any changes in the environment. It’s also pretty helpful to talk to other people about the same idea and get some contrasting opinions – this can test your thesis further.

This line of thinking is similar to what Zweig advocates next:

Step outside yourself. Imagine that someone else has suffered these losses. Think of questions you might ask to give that person advice: Other than the price, what else has changed? Is your original rationale for this investment still valid?

Then there is taking yourself away from the market:

Control your cues. Even witnessing someone else’s pain, or glancing into another person’s frightened eyes, can fire up your amygdala. Because fear is as contagious as the flu, quarantine yourself from anyone who obsesses over the momentary twitching of the Dow. Tear yourself away from the computer or television; better yet, while the market is closed, make an advance date with friends or family to get your mind off stocks during market hours.

Many of the best investors spend most of their day reading and researching. There s a definite lack of action, it is the antithesis of day trading. Some of the best investors don’t even reside in financial capitals like New York City or London. They’re often found in places that they are comfortable in. Warren Buffett has Omaha and Sir John Templeton had the Bahamas. By removing yourself from the crowd you give yourself room to think and breathe.

Finally, Zweig ends with a nod to Benjamin Graham:

Track your feelings. Fill in the blanks in this sentence: “Today the Dow closed down [or up] ___ points, and that made me feel __________.” Your emotions shouldn’t be hostage to the actions of the roughly 100 million other people who compose the collective beast that Benjamin Graham called “Mr. Market.”

The daily movements of the market are just noise; they burden us and cloud our judgment. I find that it is helpful to not really look at the movement of the market every day. One of the things I’ve noticed is that over and over, when investors like Buffett are on CNBC or Bloomberg they’re asked poor questions like “futures have moved X this morning, what are you thinking?”Often the answer is that they don’t care because it has no impact on their own investing.

Zweig’s checklist is excellent and what I like is that it is a systematic approach for re-evaluating your investments and keeping your cool under pressure. By taking this kind of approach, you distance yourself from emotions. Some of this is applicable to trading in general. A friend who recently began day trading told me that his main problem is that he’s nervous when pulling the trigger on buys and sells. I told him that his main issue is that he hasn’t really come up with a system for how he trades. Until he does, he will be at the mercy of his instincts and emotions which will prevent him from acting properly under pressure.

Zweig says that this kind of checklist will help us counteract the signals that our brain sends, so if you aren’t using one already maybe it is worth adopting. If you doubt the effectiveness of a simple checklist look at a graver scenario – being a patient in the intensive care unit at the hospital. Peter Pronovost a critical-care specialist at Johns Hopkins Hospital started employing a checklist at ICUs in 2001 with great success:

Pronovost and his colleagues monitored what happened for a year afterward. The results were so dramatic that they weren’t sure whether to believe them: the ten-day line-infection rate went from eleven per cent to zero. So they followed patients for fifteen more months. Only two line infections occurred during the entire period. They calculated that, in this one hospital, the checklist had prevented forty-three infections and eight deaths, and saved two million dollars in costs…

Within the first three months of the project, the infection rate in Michigan’s I.C.U.s decreased by sixty-six per cent. The typical I.C.U.—including the ones at Sinai-Grace Hospital—cut its quarterly infection rate to zero. Michigan’s infection rates fell so low that its average I.C.U. outperformed ninety per cent of I.C.U.s nationwide. In the Keystone Initiative’s first eighteen months, the hospitals saved an estimated hundred and seventy-five million dollars in costs and more than fifteen hundred lives. The successes have been sustained for almost four years—all because of a stupid little checklist.

The Checklist (The New Yorker)

The I.C.U. and the market have similarities. Both can be complex and terrifying, leading doctors and investors to make mistakes. Pronovost noticed that in many cases at the I.C.U. doctors would forget to take even simple precautions. In a similar sense, an investor may forget the concept of intrinsic value when watching one of their companies dive 50% in one day of trading. If you believe that in order to make out-sized market beating returns you have to take a contrarian approach, then you will have to master your fears and emotions. A checklist provides an easy way to do both.

Sir John Templeton died yesterday at the age of 95. Templeton’s ideas were a huge contribution to the world of investing, he prescribed a value-bent philosophy, but was better known as one of the first investors who advocated that we invest in foreign countries.

Today everyone seems obsessed with foreign markets, from India and China to hidden gems in the frontiers of Africa and Asia. It wasn’t always like this and we have Templeton to thank for it.

One of my most popular posts here at Street Capitalist was Learning from Eddie Lampert. I’ve always wanted to turn it into a series, and yesterday’s passing of Sir John Templeton seems like a good occasion to re-read and analyze some of his thoughts.

Templeton is famous for his maxims on investing. These basic rules or ideas that govern how you should invest in financial markets. When you read them, you’ll realize that many are timeless and should be taken to heart. They are listed below:

1. Invest for Real Returns

The idea of investing for real returns must strike people as dumb and obvious. Why else would someone invest? In reality though - many take actions when investing that actually produces negative returns.

Often, someone thinks that they are investing when they are really speculating. I characterize this as shoot for the moon investments, where you are hoping to either win big or lose your invested money. In these cases, you’re speculating or simply gambling. Then, other investors feel the need to be constantly buying and selling companies. Usually this sort of indecision leads to high commissions fees and gives your broker real returns while subjecting you to negative returns.

Investing for real returns on the other hand is an action where you not only try to preserve capital but also have that capital appreciate.

2. Keep an Open Mind

As value investors I feel that sometimes we forget to keep open minds. While we mostly spend our time investing in equities, mispricings can happen everywhere. A good example of this is with bankruptcy situations. When a company enters the bankruptcy proceedings, their equity is usually worthless and often it gets wiped out when the company emerges. However, sometimes bonds are grossly mispriced and make an optimal investing opportunity.

The same really goes for any asset class. All asset classes can become mispriced. Value investors do not simply have to look at equities, bonds or even real estate prevent opportunities as well. Seth Klarman’s Baupost Group has done over 200 real estate deals and Samuel Zell earned the nickname the “grave dancer” because of his investments in distressed properties.

I think that keeping an open mind means trying to look at all opportunities that you come across. An initial glance lets you sort them into the yes, no, and too hard buckets. This also motivates an investor to continuously learn as much as they can. You can try to learn about different industries and asset classes on a daily basis so that you can tackle a wider ranger of opportunities than most people.

3. Never Follow the Crowd

If most investors underperform the market, then generally, following the crowd should lead to under performance. I regard crowd following as detrimental because usually it showcases shoddy research on your part.

Templeton himself felt that he invested better when he moved away from New York to Nassau. It’s probably true, by being so far away he would be insulated from the manias of Wall Street and free to come up with his own more original ideas.

4. Everything Changes

Sometimes when we take positions, we become overconfident and fail to look at shifts in the environment and sectors we invest in.

Investors took positions in sub-prime mortgage companies because they felt that they were getting favorable price to book ratios. Yet they failed to take into account problems like a lock up in liquidity or the permanent impairment of sub-prime loans all together. These companies are now either bankrupt or sitting in the -90% range, neither of which is good for performance.

The key seems to be that if you have a thesis for a company, you must not only conduct thorough, but also retest it often. By doing this you can become more aware of shifts and act accordingly.

5. Avoid the Popular

The greatest inefficiencies and opportunities in the market usually come from situations that are ignored by the general population. This can be small and undiscovered areas of the market or areas in the aftermath of a panic. Think mutual thrift conversions or American Express with the salad oil crisis.

6. Learn from your Mistakes

By not learning from your mistakes, you leave yourself open to repeating them again.

“This time it is different” - No, probably not. Bubbles burst. They’ve been doing that since the 1650’s with tulips. Don’t delude yourself into thinking otherwise.

7. Buy During Times of Pessimism

The most hated and unloved areas of the market usually hold some of the best bargains. A good place to start is the 52 weeks low list.

Templeton says that we should buy on maximum pessimism and sell on maximum optimism. At the age of 26 he bought 100 shares in 104 companies that were selling at less than $1 when World War II began. In a few years, Templeton made profits on all but four of these companies which is a testament to buying on maximum pessimism.

8. Hunt for Value and Bargains

Investing in undervalued assets is difficult. Buying something that everyone is selling is incredibly difficult. Psychologically, you’re forced to question the mentality of the crowd. That’s why most investors don’t look for bargains.

However, if you accept Templeton’s idea that the crowd is usually wrong (as in 3, 5, and 7) then bargains is precisely where you need to be. How do you find bargains? Look in the red. Again, look at the 52 week low list. Also try seeing what companies are rated “sell” by analysts. Look at other asset classes that appear to be having a major sell off and apply a bottom-up analysis of them.

9. Search Worldwide

Bargain hunting is a universal concept. Go wherever you can find good accounting standards and good management. You’ll find more opportunities which can be particularly important if your own domestic market becomes overheated. By investing in multiple markets you can diversify or hedge against problems in your own nation.

Frontier markets can be an excellent place to look. They are normally less correlated with global markets and not followed by average investors. I have a feeling that we’ll see more investors stalk companies in Africa and Asia as they look for opportunities, especially if the credit crunch continues.

10. No-one Knows Everything

If we’re close-minded, we don’t learn. It inhibits learning and the finding of new investing opportunities. That’s why I think communication is important. One of the best things about blogs and investing communities is that you can bounce your ideas off of each other and hear contrary views. All of this will refine your own analysis and either make it stronger or show you the holes or failings of your investment idea.

I also use blogs/communities to find out how to invest in other assets. While I have only invested in equities so far, I’ve reached out to certain bloggers to learn more about sectors that I didn’t understand, or assets like currencies which I knew nothing about. You should try practicing this too. Continuous learning is a healthy and rewarding objective to have for yourself.

Now take a moment to follow this link to Templeton’s obituary in the New York Times. I spent most of this post discussing investing, but the article goes into some of the more important aspects about Templeton. His life, his philanthropy, and his family.

Mr. Templeton said his investment record improved after he distanced himself from Wall Street and no longer worried about the tax consequences of his decisions. He was an early investor in Japan in the 1960s and later in Russia, as well as in China and other Asian markets. He sold large holdings before the technology bubble burst in 2000, and warned several years ago that real estate prices were dangerously high.

In Nassau, his net worth swelled into the billions, but his lifestyle remained relatively modest. He drove his own car and spent his days reading, writing and managing his foundation. Visitors were given sandwiches, tea and courtly advice in the afternoon at his white-columned antebellum-style home on Lyford Cay, set on a hillside lush with citrus trees and bougainvillea, overlooking a golf course and the ocean.

John Templeton, Investor, Dies at 95 (NY Times)