What is investing? It can be thought of as a collection of buy and sell decisions.
- Pick security to buy.
- Pick price you want shares at.
- Enter order.
- Get fill.
Everyone knows there's more to it than that though. There is a relationship between the decisions because they involve the same person's money in the same account and when one thing is bought, usually something else must be sold first. In short, investing is really a related collection of decisions and the overriding relationship is one's investment approach.
This article will discuss my investment approach and some general thoughts I've had recently on the subject.
"Value Investing" Does Not Equal Buying Cheap Stocks
Everyone is a value investor these days. It's become a ubiquitous term and has almost no meaning anymore. I suppose the meaning is one who ascribes to Ben Graham's notion of intrinsic value, arguably his biggest contribution to investment theory. A value investor is one who believes an underlying intrinsic value for assets exists, tries to identify it, and tries to buy assets when their appraisal of intrinsic value significantly exceeds the purchase price. That's very, very broad. Not too many people would say there is no such thing as intrinsic value. Even the efficient market hypothesis academic types acknowledge the existence of intrinsic value, they're just saying that market prices quickly reflect it.
So really all intelligent investing is value investing and as such, it's not a particularly useful term to describe an investment approach anymore. Yet there's still this notion in some circles that value investors are these guys buying the cheapest stuff in the market; that value investors are extremely price sensitive. I disagree.
I think many, many value investors are more sensitive to things like business quality, management, catalysts, etc., and that they are using these qualities to justify paying above average prices for securities. Valeant (NYSE:VRX) is a great example. When Bill Ackman originally bought shares in Valeant, it was trading over 5x book value (and much of that was intangibles) and like 30x P/CF (which does not account for the net debt position or maintenance capex requirements). Sure Bill Ackman is a fundamental investor and undoubtedly had 50MB Excel models justifying his purchase price assuming continued acquisitions and platform value. But beyond all of that, is paying a price like that really value investing? It certainly doesn't jibe with the typical idea of a value investor being extremely price sensitive. Perhaps Ackman is a value investor, but he wasn't buying cheap stocks. And that's my point. The two are often confused but shouldn't be.
In my mind, everyone can't be buying cheap stocks. In a market, half the participants are paying below average prices and half are paying above average. Only half the market is truly deeply price sensitive investors buying cheap stocks. I want to be one of them so I try to identify by Walter and Edwin Schloss' famous reply when asked to describe their investment approach: "We buy cheap stocks." Saying that I'm a value investor just isn't enough to give me any kind of identity these days.
The Groceries vs. Diamonds Analogy
Having formed an investment management firm not too long ago, I have been thinking of ways to effectively communicate the way I invest to non-investors. Graham once said to buy stocks like you would groceries, not perfume, which I think is an effective analogy that I can add detail to. I think the way perfume is bought has changed a little since Graham's time though and that a shopping experience like buying diamond jewelry today better depicts the experience Graham based his analogy on. So how exactly does buying groceries differ from buying diamonds?
Conflicted advisor vs. self-directed search
There is a saying that most financial products are sold, not bought. This applies to individual securities as well. Most investors solicit opinions from peers, brokers, management teams, or sell-side research on investment ideas, all of which can be conflicted advisors talking their book or looking for commission-heavy relationships, offloading IPO shares, etc. These are the salesmen in the jewelry store telling you whatever you need to hear to get you to buy something, preferably the highest dollar diamond in the store as their commission is tied to it. By contrast, grocery shopping is pretty self-directed. Sure some things are placed in the front of the store where there is more traffic to encourage you to buy (I am so tired of walking a half mile to the back of a Wal-Mart (NYSE:WMT) Supercenter to get butter, eggs, and milk) but the sales pressure is far lower.
Time/Idea and Number of Ideas Researched
The typical diamond shopper spends A LOT of time studying individual diamonds. Where did it come from? Who crafted it? How many carats is it? How is it cut? Likewise, many investors buy stocks by performing very deep research on individual securities. We are in the age of deep research and "due diligence." Me, on the other hand? I am zooming through the store using my shopping cart as a scooter looking at price tag after price tag. If I can, maybe I'll get access to the store's inventory database and look at metrics like price/calorie. I ascribe to the view that if it doesn't look cheap on the surface, chances are it's not and no amount of research can make it cheap unless I'm fooling myself using mental gymnastics and aggressive assumptions. That's not to say I don't adequately vet stocks that I buy- I do. I just don't keep looking at them until they look like a buy. My default is to move on to the next one, not keep staring if I see some dealbreaker, inadequate upside, etc.
Number of Stores Visited
Many jewelry shoppers have "their" jeweler who does all the repairs, adjustments, and fittings on their jewelry and is their trusted advisor. This is where they do all their business. With groceries, different stores have different prices on different products at different times. Sure, many grocery shoppers stick with one store, but I like to jump around to wherever the best deals are. If prices in Wal-Mart (the S&P 500) are expensive, I'm willing to go to a smaller grocery store founded on bargain prices like Aldi (OTC microcaps) and other stores (international developed markets). At any given time, there's got to be a good price somewhere. As Peter Cundill would say, "There's always something to do."
Diamond buyers become emotionally attached to "the ring." Women look on Pinterest and other sites for the ring they want tell their girlfriends to send it to "lucky" guy. "I've got to have this one," they'll say. Likewise, investors can become mentally endowed to their holdings and not want to part with them. Or they develop an emotional connection with the company after speaking with management or using the company's products/services and have to own it. I am (try to be!) more dispassionate. Shopping for groceries, I don't really care what brand I buy. They're all the same. Private label Frosted Flakes are the same as Kellogg's. Any stock is replaceable. There are thousands of cheap stocks out there. If I try to buy one and the price rises above my limit, I'm not going to chase it because I don't need it. I'll just find another cheap stock to buy.
Number of and Valuation of Holdings
Diamond jewelry is extremely expensive and because of the cost, time spent researching each purchase, and emotional attachment, few are held but held tightly. Groceries are much more numerous in quantity and are much cheaper. Similarly, I stay very diversified holding between 20-40 stocks and my holdings are demonstrably cheaper than most - don't take my word for it, look at objective metric like P/TB, P/NCAV, EV/FCF, etc. at the holding and portfolio level.
Stories vs. Numbers
Diamond buyers want to know the story of the diamond and other qualitative information. Where did it come out of the ground? Who designed it? What kind of love does it symbolize? How many years of marriage will this $20,000 object guarantee? As a grocery shopper, I care about the numbers. What's the price (and I'm talking constant unit prices so I can compare)? How many calories are in the package? How many calories, grams of protein, etc. am I getting per dollar spent? With stocks the same is true. I don't care nearly as much about the CEO's personality as I do about price to tangible book and earnings. I invest in numbers, not stories.
By now hopefully it is clear that there is a huge difference between grocery shopping and diamond shopping and I believe equally large differences exist between my investment approach and others. That's not to say mine is the best - I certainly think it is but I'm very biased. There's many ways to make money and I think my personality is a big consideration, which I'll discuss in a later post.
This has really just been a few random musings but to summarize each thought in a few sentence:
- "Value Investing" has become a broad, almost meaningless term and "value investing" does not equal buying cheap stocks.
- Everyone can be a value investor, but not everyone can be a buyer of cheap stocks.
- There is more truth than you'd think to Graham's advice to buy stocks like you buy groceries and I believe it is a good analogy for my investment approach.
- Along the lines of my view that not everyone can be a "cheap-stock-buyer," it is important to recognize that massive philosophical and tactical differences exist among active investors today, despite the ubiquity of value investing.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.