Anthony Bolton earned the stellar reputation as Britain’s Warren Buffett when he was head of Fidelity Special Situations Fund in the U.K. With exquisite timing, he stepped down in 2007, at the top of the bull market, and boasted of annualised returns of 19.5% over the 28 years he was at the helm.
Here are some investing lessons from him.
- Know what you own and why you own it.
Every stock must have an investment thesis, but one must go beyond. The thesis must be retested at regular intervals and a counter thesis should also be in place - what might lead it to become a bad stock.
Bolton believed that there would be some reasons certain investors don’t like the shares regardless of how positive the outlook for a company and he, as an investor, should know why he disagrees with each of the negative factors.
An interesting suggestion is that investors forget the price they paid for a share, otherwise it becomes a psychological barrier if the share price subsequently falls. If the investment thesis changes for the worse and the share is no longer a buy and probably a sell, the investor should take action regardless of the price being below what they paid. Trying to make money back in a share where you have lost money to date just to prove your initial thesis correct is dangerous. If the investment thesis is broken, the shares should be sold even if the valuation is attractive.
- Know your sell thesis; not just the buy thesis.
Bolton listed three main reasons to sell: Something negates the investment thesis; it meets the valuation target; he found something better.
To test his conviction in a stock, he would look for a similar company that gets his attention and fancy and compare the two directly. When doing so, clarity would emerge as to which one he prefers considering all the relevant factors. It also helps prune out those on which there is less conviction.
Avoid emotional attachments.
- Know what’s discounted in the price.
Bolton’s approach to investment is to buy shares that represent a valuation anomaly and then wait for the anomaly to be corrected. Since it is easier to spot an anomaly than knowing exactly when it is going to correct, it is wise to have time on your side.
Consequently, his holding period could vary from one year to many. If he believed his thesis to be bang on, he would wait for several years even if there was no short-term catalyst.
He has no favourite valuation measure but looks at a range of them, on an absolute and relative basis.
- P/E. The ratio of the price to predicted earnings in the current year and up to the two following years.
- Prospective ratio of the Enterprise Value to gross cash flow or EV/EBITDA, making sure the EV is adjusted for items such as minorities and pension fund deficits.
- Prospective free cash flow i.e. the prospective cash the company is expected to generate per share divided by the share price.
- Price to sales chart or, if available, an EV to sales chart.
- Cash flow return on investment (CFROI) in relation to how the share price trades relative to invested capital. Businesses that make returns above the risk-free rate are expected to trade at a premium to their invested capital and vice versa.
Importantly, he cautions that investors use the valuations most appropriate for the industry in concern. For instance, he cites PE ratios as pretty meaningless for house-building shares because of the once-off nature of profits on land sales, but price to adjusted book value is most helpful in such cases.
Know yourself.
There are many approaches to making money in the stock market. You must be able to establish what works for you personally and suits your temperament and stick to it. In fact, Bolton believes having the right temperament is more important than IQ. Having a reasonable level of intelligence is essential but being super intelligent without the right temperament is useless.
He has often emphasized that emotional people don’t make good investors.
Know the business
Businesses are not created equal. Some are much better than others. Most businesses vary over time due to factors such as new competition or changes in the environment. Bolton prefers simple businesses and tends to avoid those where the business model is difficult to understand.
He also believes that it’s easier to make money owning businesses with strong franchises than weak ones. He questions: How likely is this business to be around in 10 years’ time and to be more valuable than today? How much does a particular business stand on its own two feet: how does it exist relatively independent of the macro factors around? Businesses very sensitive to interest rates or currencies are less good businesses than ones insulated from such factors. An exporter of commodities would fall into this sensitive category.
He looks at relevant ratios. For instance, when looking at banks the relationship between the price to book value and the return on equity is very important. But he is a great believer that cash-generating businesses are superior to ones that consume cash; hence he preferred services to manufacturing. Businesses that can grow without requiring a lot of capital are particularly attractive. Cash-on-cash return, for him, was the ultimate measure of attractiveness in terms of valuation.
Know the balance sheet
When something goes wrong at a company with a weak balance sheet this is when equity investors lose the most. And investing is as much about avoiding disasters as it is about picking winners. Take balance sheet risk seriously.
When looking at liabilities you should look at both bank debt and bonds outstanding as well as being aware of other liabilities such as future payment obligations, pension fund liabilities and redeemable preference shares.
Understand the debt profile. The debt level can vary seasonally or during a quarter. In such instances, looking at absolute debt levels at the year-end may give a misguided impression about the strength of the company. Also, look at the net interest figures.
However, most companies use debt and that does not make it bad news. Debt used sensibly can increase returns substantially for investors.
