Value Investing Mindset: Diamond Dealer Edition

Includes: DIA, QQQ, SPY
by: Nadav Manham

One of my themes is that the value investing mindset, the ability to buy at the largest discount between present price and future intrinsic value, can be found and studied inside of businesses too, not just in people who buy stocks for a living.

Lots of professional investors lay out money to buy a stock they hope to sell within about two years at a big profit. This article from the NYT style section demonstrates that professional diamond dealers do the same thing, and at the highest end they do it Buffett/Munger-style, by making big concentrated bets.

In December 2008 Laurence Graff paid $24.3 million for the legendary (to him, not to me) Wittelsbach diamond. That $24.3 million became inventory, part of working capital. It's called working "capital" for a reason, and like any other kind of capital it's supposed to earn a return, in cash. I used to know this only in the abstract; it was only when I got involved in a small private equity venture that I came to understand it in my bones: working capital sucks.

Working capital, namely inventory and/or accounts receivable, is a kind of Purgatory for cash, a painful but necessary intermediate state between cash lying around doing nothing and making cash money from a business. No one wants to enter Purgatory unless there is something better on the other side, and for working capital that "something better" is an acceptable return on the pre-Purgatory cash you started with. Laurence Graff is a billionaire who owns a private company; there was no shortage of opportunities for him to do something else with that $24.3mm. That he chose to invest it in one blue rock means 1) he loves the game and 2) he thinks he can earn a better return from investing in diamond working capital than from anything else.

The article goes into some of the reasons why, which convince me he has a good shot at earning a good return on his investment. It comes down to know-how and lack of competition. Thousands of people and institutions can invest $24.3mm in a stock, but I can count on my hands the number of people who know how much to bid for a diamond like the Wittelsbach, and then know how to maximize its value two years out (an eternity in working capital-years!), first by cutting and polishing it properly, then by creating just the right kind of buzz via a Smithsonian exhibition, then by knowing the names and diamond-buying habits of every single potential buyer in the world, then by setting it just right in a necklace, then by selling it at the best price, and finally, last but not least, by collecting the money in cash (that last part is harder than it seems).

Laurence Graff dropped out of school at 14. If he took an MBA investing class I suspect he would fail. If he read this post I suspect he would have no idea what I'm talking about. But whether he knows it or not, in his little corner he's the world's greatest value investor. And furthermore, if you shake the family tree of the world's other greatest value investors, you'll almost always find a grocer, or a dry-goods merchant, or maybe even a diamond dealer--someone who knew all about value investing in working capital.