I learn more by reading about how great investors who weren't value investors invested, than by reading the 200th book about value investing.
That’s Bill Nygren of Oakmark Funds. Known for his candour, as much as for his distinctive approach to value investing.
He has the intestinal fortitude to hold on to his investing principles, even if the market is ruthlessly penalizing him for doing so.
This incident will drive home the point.
The Oakmark fund had assets of around $10 billion in 1997-98. The following two years, though the NAV had been about flat, assets were down to $2 billion. Because he refused to buy any stock in the technology space.
One of the advisers, who was in the process of selling out of the fund was, attempted to strike a bargain with him saying that if he just bought at least one technology stock, she could go back to her investment committee and convince them to hold on to this investment.
His response is a testimony to his discipline.
If we could find one that fit our value criteria, we'd happily own it, but we can't. Because of that we won't.
I'll bet you something else. There is going to be a time in the future that you're going to say, "It's not that Oakmark's incapable of buying technology, but when technology is out of favor, we're going to own more than the market weighting in it. And you're probably going to be just as upset with us then as you are now, because we're investing in something then that would be unpopular."
Here are some insights from Bill Nygren
The importance of considering intangibles when valuing businesses today.
GAAP accounting was really invented for the industrial age, an asset heavy economy, where your most important assets were buildings and factories. In more and more of the economy today, BV isn’t a good measure of business value. The linkage between BV and business value has been broken because so many important assets today are intangibles and don’t even show up on the balance sheet.
Things like R&D expense or customer acquisition costs as companies are trying to expand their global platforms. When you look at a bio-technology company for example, the R&D spend that they do today, that will benefit them for the next decade, all gets expensed immediately, depressing their reported earnings.
So you need to look deeper that the reported GAAP EPS number when you think about how much value has been added in a company in any given year.
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We try to identify business value, demand a significant discount to that, look for management teams that are aligned with the outside shareholders, rather than pick a favorite metric and then do all of work based on that metric.
Sometimes you can get comforted by a cheapness statistic like low P/B value, and then retailers that are on their way out of business that look very cheap compared to book value still go bankrupt because they don't get the useful life out of the assets that the accountants depended on when they decided on what number book value should be.
I don't think there is necessarily more risk in straying from the low P/E, low P/B value metrics. I think it's just a natural step that as the economy has changed to more asset-light business models that more and more of the assets are not things that you can touch and feel and say, "We'll have a 7-year life," so you depreciate it over that time. The way gap accounting works is if you can't touch or feel something, it's basically expensed immediately.
So, R&D expenditures are all going straight through the income statement. Customer acquisition costs all go straight through the income statement. That can really present an unfair presentation of what a company is accomplishing in a given year.
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In the area where we've gotten less comfortable because we don't think we've been very good at it, and where we have grown more confident…..
Where you think a stock is so cheap that you can tolerate a management team that you'd rather not be invested with. We've learned the lesson too many times about how much damage a management team can do that's not focused on what's best for the shareholders. So, rather than trying to make that a question of what price would we be interested in investing with management teams that are subpar, we've made those more off limits.
We have grown more confident in areas that are often called technology, but maybe like Alphabet or Netflix. They're companies that are using technology in a more traditional industry, where they've developed the scale that you're quite comfortable forecasting out what the business might look like seven years from now.
In the '80s, we had to consider most of the technology companies off limits because they hadn't developed a scale yet that had created a safety net. There's always the story of two high school kids in a garage potentially disrupting a leader in the computer industry. That's not going to happen today to a Netflix, an Alphabet, a Texas Instruments. Those companies have developed a scale that you don't have to worry about a newcomer completely disrupting them.
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We don't ever want to be the investor that says "If the stock falls 20%, it's an automatic sale."
We're not momentum investors by any way, shape, or form, but I do believe there is such a thing as fundamental momentum. That companies that are performing well are more likely to continue performing well, and companies that are performing poorly are more likely to continue poorly.
George Soros, with his theory of reflexivity, says (way, way oversimplified) that what's going on emotionally in investors can actually influence the real economy and that psychology has a real effect on the economy, and when direction changes, a simple psychological change can be enough to bring about a real change in the economy. When you go through tough cycles like 2008-09 and people are always saying, "Sure, if things get back to normal, then everything out there is really cheap and the names you own would be the right basket of names to own." But what can ever change to make things get better? Just thinking that things could change to get back to normal can be an impetus to start that process happening.
In the same way that if you've gone through an extended recovery that's created tremendous excess in the economy, just people starting to worry that things go back to normal could be enough to slow the speculation, slow price increases and bring things back to normal.
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Investment involves risk of loss
