In a recent conversation about asset allocation with an astute growth investor, I was surprised he dismissed the possibility of a socialist as President. He simply could not see that happening and, therefore, it could not serve as a reason for changing a traditional 60 percent equity/40 percent bond mix in a target allocation. He may be right about that risk, which was known, but what about something unknown like Covid-19?
I deeply respect smart money opinions, but I am a value investor and value investors are trained to expect the unexpected. At the heart of value investing is a conviction the future is unknowable. Whether it is a socialist in the White House, Covid-19, or Trump defeating Clinton, Brexit, or a Saudi oil price war, investing is merely “speculation” for guys like Howard Marks, Joel Greenblatt, Warren Buffet, Bruce Greenwald, and Seth Klarman, unless it has a margin of safety.
I have doubled down on reexamining the written word from the great value investors and I present them here because these guys have been on the sidelines, and mostly out of favor, for a long time. You won’t hear their names as thought leaders for 2020. Possibly, the threat of a global shut down in response to Covid-19 will refocus investors on risk associated with momentum investing?
Here are the books I have been reading:
- “The Essays of Warren Buffett” by Lawrence Cunningham
- “Value Investing: From Graham To Buffett and Beyond” by Bruce Greenwald
- “The Most Important Thing” by Howard Marks
- “Margin of Safety: Risk Averse Value Investing Strategies for The Thoughtful Investor” by Seth Klarman
- “The Little Book That Beats The Market” by Joel Greenblatt
In addition, I have read Jeremy Grantam, and have heard Jim Grant speak in Cleveland. Universally, all of these value investors channel Graham and Dodd and their most eloquent, modern day proponents: Warren Buffet and Charlie Munger.
Buffet Pearls of Wisdom
Here a few pearls of wisdom from Buffett …
- “Investing is 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! US Steel at 39! And nobody calls a strike on you. There is no penalty except opportunity. All day you wait for a pitch you like; then when the fielders are asleep, you step up and hit it”
- “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
- “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
- “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
- “Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
- “Beware of geeks bearing formulas.”
Seth Klarman Sits On Cash
Seth Klarman is also one of my favorites. He manages a successful hedge fund called Baupost with $32 billion under management of which more than 30% is in cash. Here are a few of his insights from “Margin of Safety”:
- “The focus of most investors differs from that of value investors. Most investors are primarily oriented toward return, how much they can make, and pay little attention to risk, how much they can lose. Institutional investors, in particular, are usually evaluated—and therefore measure themselves—on the basis of relative performance compared to the market as a whole, to a relevant market sector, or to their peers.”
- “A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes. It is adherence to the concept of a margin of safety that best distinguishes value investors from all others, who are not as concerned about loss.“
- “Mark Twain said that there are two times in a man‘s life when he should not speculate: when he can‘t afford it and when he can. Because this is so, understanding the difference between investment and speculation is the first step in achieving investment success.”
Howard Marks Recommends Buying Cheap
Howard Marks is another one of my favorites. He manages Oaktree Capital Management in Los Angeles with $80 billion under management. Here are a few of his insights from his book “The Most Important Thing”:
- “Theory says high return is associated with high risk because the former exists for the latter to be compensated. But pragmatic value investors feel just the opposite: They believe high returns and low risk can be achieved simultaneously by buying things for less than they are worth. In the same way overpaying implies high risk and low returns”
- “Of all the possible routes to investment profit, buying cheap is clearly the most reliable. Even that, however, isn’t sure to work. You can be wrong about current value. Or events can come along that reduce value… Or the convergence of price and intrinsic value can take more time than you have; as John Maynard Keynes pointed out, ‘The market can remain irrational longer than you can remain solvent.’”
- “It seems to me the choice isn’t really between value and growth, but between value today and value tomorrow. Growth investing represents a bet on company performance that may or may not materialize in the future, while value investing is based primarily on an analysis of a company’s current worth.”
- “To simplify (or oversimplify) all approaches to investing in company securities can be divided into two basic types: those based on company attributes called ‘fundamentals’, and those based on the price behavior of the securities themselves. In other words, an investor has two basic choices: gauge the security’s underlying intrinsic value and buy or sell when the price diverges from it, or base decisions purely on expectations regarding future price movements.”
Joel Greenblatt Has A Magic Formula
Finally, I read Joel Greenblatt’s book “The Little Book That Beat The Market.” For less than $15, you can get access to Joel’s model portfolio based on his two-pronged approach to discovering undervalued stocks.
“Joel Greenblatt is an American academic, hedge fund manager, investor, and writer. He is a value investor, alumnus of the Wharton School of the University of Pennsylvania, and adjunct professor at the Columbia University Graduate School of Business. He runs Gotham Funds with his partner, Robert Goldstein”. (Source:Wikipedia).
Here are a few of his quips:
- “Choosing individual stocks without any idea of what you are looking for is like running through a dynamite factory with a burning match. You may live, but you are still an idiot.”
- “Figure out what something is worth and pay a lot less”
- “Remember it is the quality of your ideas, not the quantity that will result in big money.”
- “One way to create an attractive risk/reward situation is to limit downside risk severely by investing in situations that have a large margin of safety. The upside, while difficult to quantify, will usually take care of itself. In other words look down, not up, when you are making your initial investment decision. If you don’t lose money, most of the remaining alternatives are good ones.”
Reading About Value Is A Cathartic Exercise
This exercise has been cathartic for me. All of these brilliant value investors have been completely wrong about market returns for the last 5 years as they sold and held large pots of cash. But they must be right about risk because the stock market has recently lost almost 20 percent of its market value. Covid-19 and oil price wars are just a reminder about the future being unknowable. Invest with a margin of safety.