Dear Friend,
Every year, it seems, the media makes a big fuss about “Black Friday” – the traditional beginning of the holiday shopping season.
Truth is – this kind of story is fastball right down the middle for most media types. It’s very easy for local television stations to send reporters to a local shopping mall or big box store to capture the frenzy of shoppers racing after bargains at odd hours.
And the financial press, naturally, makes a big deal out of “Black Friday” when it comes to retail sales as well. That sort of coverage is only intensified in a year like this one – when “experts” look to sales figures from a single day as if they could foretell an early end to the recession…or six more weeks of winter.
But there is a certain, fundamental truth about “Black Friday” that often gets overlooked.
At the end of the day…what is it that consumers are looking for? They’re looking to buy solid products – gifts they know their loved ones will enjoy – at the lowest possible prices.
And while I don’t necessarily agree with the idea of heading out to the store at 4:00 a.m. and standing in line to buy gifts…I think we all have to admit that when you look closely at “Black Friday” – you see that many of the consumers are exhibiting some of the most basic traits of the world’s most successful Value Investors.
What does it take to be a Successful Value Investor?
Not long ago, while delivering a presentation, I was asked a very simple question:
What does it really take to be a successful value investor?
I thought for a few seconds and answered, “Think differently and independently.”
That was my two-second sound-bite answer; it was perfect for an interview or presentation but didn’t really answer the question.
Since being asked that question, I’ve thought long and hard on what it takes to be a successful value investor. And hearing all the talk about “Black Friday” reminded me that everyone – at some level – has a desire to become a successful value investor.
So I wanted to be able to boil it down to a few main traits that I have learned and observed from the “value gurus”. Let’s get started with the world’s most famous value investor – Warren Buffett…
What’s The Secret?
Many people know that Warren Buffett reads a lot of newspapers - perhaps that is the secret?
While it is true that Mr. Buffett reads The New York Times, the Wall Street Journal, USA Today, the Financial Times, the Omaha World Herald and American Banker every day, reading won’t guarantee investment success either.
In the mid-1970s the Reichmann family of Toronto bought a package of eight skyscrapers in Manhattan for a fraction of their value. Over the next decade, their development company, Olympia & York, was the greatest property development company in the world. At its peak the company was worth over $10 billion.
The genius of the family was Paul Reichmann, an Orthodox Jew who said that his commercial decision making was rooted in Talmudic methodology. It was said that real estate brokers in London and New York could be seen leafing through the Talmud in hopes of discovering Reichmann’s secret.
You won’t find the “secret” in high IQs, college degrees, experience or reading. Keep in mind that while all these will help you, in and of themselves they are not the secret. Perhaps by looking at training and occupations we can come closer to finding what it takes for success? Looking at the occupations of the investors Warren Buffett showcased in his presentation on “The Super Investors of Graham and Dodgeville” (1984) still offers no clue.
Buffett showed the track records of great value investors who came from all walks of life: a lawyer, an IBM salesman, a chemistry major, an advertising executive, a high school graduate. They all shared the same investing principles laid down by Benjamin Graham, but not much else.
Without teasing you any longer, the secret boils down to temperament: how strong one’s convictions are and how stringently one sticks with them.
Confidence
Value gurus seem to think differently than other people. They get enjoyment from being immersed in the company they are researching, becoming fluent with the financial statements and then forming opinions based on their findings. I can’t recall reading about a value guru who offered “my gut” as the thesis for an investment idea. That is far from the way the majority of value investors behave.
Instead, a valuation on the security is formed after all the facts are gathered, and not before. These investors are not concerned if they are in the minority; in fact, most of them like to be invested where most investors fear to tread. Those investments most times offer the greatest returns. They understand and completely believe that over the short term stock prices move based on popularity, and over the long term based on the fundamentals of the company.
It really boils down to having an information edge over Mr. Market and a way to determine the value of the company. If you don’t know, you’ll have to take the last price the stock traded at in order to determine the value of the company. By rolling up your sleeves and diving into the annual reports and financial statements, you’ve begun to develop an edge by discerning if the company is efficiently priced by Mr. Market or not. Just by reading the past five years’ annual reports and the current annual reports of its competitors, you will have gained more insight into the company and its industry than most people who buy and sell the stock on a daily basis.
Assume the house next door to you is being sold by the county at a public auction. Since you have lived in your house for the past 30 years, you have a very good idea of its value and that of the one next door. The auction draws a nice crowd of locals as well as out-of-towners. Since you know the neighborhood, the condition of the house, how it was maintained, etc., you have clear edge over most of the other bidders.
The bidding starts at $100,000 and quickly goes up to $225,000 before stalling out. The auctioneer says,“Going once, going twice…,”and before he is about to bang the gavel, you raise your hand and bid $250,000…and win the auction. Why did you bid more than everyone else and win? Simply because you knew that homes on your block are selling for over $500,000. In fact, your next-door neighbor on the other side just rented his home for $25,000 a year to two college professors while he went on a year-long cruise.
In other words, the price wasn’t as important to you as it was to most of the bargain hunters; you saw an opportunity to buy $1 worth of assets for 50 cents. Your downside risk was minimal and you did not let the lack of other bids scare you into thinking, “How come I’m the only one left bidding?”Instead, you had confidence in making that bid because you were informed, had a very good idea of the value and were able to buy it at a significant discount to your valuation. That’s the type of confidence I’m talking about.
Conviction
Why is it so important to do your own research and have a high level of confidence in the value of a company? Sometimes Mr. Market is erratic, in that he will offer a stock price that is down 20 percent or more from the previous day’s closing price because of an analyst downgrade or perhaps the company missed their earnings target by a penny.
An owner of the stock who bought it because of a tip from a friend will be shaken and sell into the downdraft. But since you know the value of the company, you view times like these as opportunities and take advantage of them. In hindsight, these purchases will make all the sense in the world and will become so obvious to so any. However, during the panic very few investors are willing to step up to the plate, because they lack conviction.
Watching their stock account drop 40 percent or more over a short period of time is a very painful experience for most investors. In order to stop the pain, they sell at any price. Value gurus fight this instinct of fear and let the confidence of their research and the conviction of their thesis win the day. This is not as easy as it sounds. It is very hard to keep your head when everyone around you is losing theirs, but that is what separates the great investors from the mediocre ones.
Conclusion
What do value gurus have that most investors don’t?
As demonstrated by their purchases of stocks that have been vilified in the press and seen their prices plunge, value gurus have confidence in their valuations and the conviction to act.
If you can keep your head while all around are losing theirs, then you have a very good chance to become a value guru.
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This post was originally sent on 11/29/09 to the Hidden Values Alert email list