In the following article, there are a few super investors in US which I have been following on their investment principles, philosophies and methodologies.
They are Warren Buffet, Joel Greenblatt, Seth Klarman, and Howard Marks, and some others. If you have been reading my articles, you will notice that I have been quoting these people all the time. They are fundamental value investors, of course, but who exactly are they, and why are they worth to enumerate by fundamental value investors?
Let us look at each of them one by one from the angles of their investing philosophies, principles and methodologies.
Warren Buffett
Warren Buffett requires little introduction. He is the most successful investor in the world. Buffett is the chairman, CEO and largestshareholder of Berkshire Hathaway, and is consistently ranked among the world's wealthiest people with a net worth of USD62 billion.
Buffett is noted for his adherence to value investing, and a notable philanthropist.
That $1,000 invested in 1964, when Buffett took over the company and shares cost just $19, would be worth about $11.5 million dollars today. This is equivalent to a compounded annual growth rate (CAGR) of about 20% for a long period of 51 years.
Warren Buffett’s investing principles focus on return of equity, ROE. This is his thought.
“Customarily, most investors measure annual company performance by looking at earnings per share (EPS). Did they increase over last year? Are they high enough to brag about? For his part, Buffett considers EPS a smokescreen. Most companies retain a portion of their previous year's earnings as a way of increasing their equity base, so he sees no reason to get excited about record EPS. There is nothing spectacular about a company that increases EPS by 10%, if at the same time, it is growing its equity base by 10%. That's no different, he explains, from putting money in a savings account and letting the interest accumulate and compound. Worse still, there are many companies borrow huge amount of money to improve EPS, but the marginal return is way below its borrowing costs.
The test of economic performance, he believes, is whether a company achieves a high earnings rate on equity capital ("without undue leverage, accounting gimmickry, etc."), not whether it has consistent gains in EPS. To measure a company's annual performance, Buffett prefers return on equity or ROE. -- The ratio of operating earnings to shareholders' equity.”
The test of economic performance, he believes, is whether a company achieves a high earnings rate on equity capital ("without undue leverage, accounting gimmickry, etc."), not whether it has consistent gains in EPS. To measure a company's annual performance, Buffett prefers return on equity or ROE. -- The ratio of operating earnings to shareholders' equity.”
Buffett looks at what he calls "owner's earnings," which is essentially cash flow available to shareholders, or technically, free cash flow to equity (FCFE), after capital expenses for the business. He focuses on the ability of a company to generate cash for shareholders, and not how much earnings produced.
Here, Buffett seeks to estimate a company's intrinsic value. He projects the future owner's earnings, then discounts them back to the present to get the intrinsic value of the company and hence its stock. He would only invest in it if there is a wide margin of safety.
On the short-term behavior of most investors trying to make quick gain, he said,
“No matter how great the talent or efforts, some things just take time. You can't produce a baby in one month by getting nine women pregnant.”
This is a good advice from Warren Buffett for investors regarding the greed in the stock market:
“I've seen more people fail because of liquor and leverage—leverage being borrowed money. You really don't need leverage in this world much. If you're smart, you're going to make a lot of money without borrowing.”
Joel Greenblatt
I have mentioned about Joel Greenblatt in my investment articles in i3investor a lot because my investing principle is mainly based on his Magic Formula Investing. Here is one of the articles.
Joel Greenblatt is an American academic, hedge fund manager, investor, and writer. He is a value investor, and adjunct professor at theColumbia University Graduate School of Business.
In 1985, Greenblatt started a hedge fund, Gotham Capital, with $7 million. Through his firm Gotham Capital, Greenblatt presided over an impressive CAGR of 30% from 1985 to 2006. The $7 million capital turned into $1.7 billion 21 years later.
Joel focus on buying good companies at cheap price. Good companies again mean companies with high return on invested capital, ROIC and not earnings growth, and cheapness measured by earnings yields, and not the simplistic PE ratio.
This is Joel’s thoughts about stock price and value:
“I just want to take advantage of prices away from value. If you do good valuation work and you are right, Mr. Market will pay you back. In the short term, one to two years, the market is inefficient. But in the long-term, the market has to get it right—it will pay you back in two to three years. Keep that in mind when you do your analysis. You don’t have to look at the next quarter, the next six months, if you do good valuation work—Mr. Market will pay you.”
“Buying good businesses at bargain prices is the secret to making lots of money.”
Joel also emphasize this, like all other super investors,
“Companies that achieve a high return on capital are likely to have a special advantage of some kind. That special advantage keeps competitors from destroying the ability to earn above-average profits.”
The stocks of My First Portfolio published in i3investors were chosen using the Magic Formula principle of investing. It returned 116% compared to the return of KLCI of just 9.6% during the same period of two years and nine months as shown in this link here:
I particle like what Joel says here:
“Look down, not up, when making your initial investment decision. If you don’t lose money, most of the remaining alternatives are good ones.”
On leverage in investing, Joel said:
“If you are going to be a very concentrated investor, you should not use leverage. You can’t leverage because you need to live through the downturns and that is incredibly important.”
Joel also warned investors about stock tips and advice from people purportedly want to make you rich.
“The odds of anyone calling you on the phone with good investment advice are about the same as winning the Lotto without buying a ticket.”
Seth Klarman
Seth Klarman is an American billionaire who founded the Baupost Group in 1982, which managed USD 22 Billion as of 2010. He has consistently achieved high returns. He often makes unusual investments, buying unpopular assets while they are undervalued, using complex derivatives, and buying put options.
Seth obtained 17 percent annualized return for the Baupost Group since its inception three decades ago. $100k invested in 1982 becomes $11.1m at the end of year 2012.
In 1991, Klarman authored Margin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor, which since has become a value investing classic. Now out of print, Margin of Safety has sold on Amazon for $1,200 and eBay for $2,000.
In 2014 Forbes listed Seth Klarman as one of the 25 Highest-Earning hedge fund managers in 2013. His 2013 total earnings was $350 million ranks him the 20th among the 25 top earning hedge fund managers.
Below is the gist of valuation technique used by him which I have been trying to follow:
“To be a value investor, you must buy at a discount from underlying value. Analyzing each potential value investment opportunity therefore begins with an assessment of business value…. While a great many methods of business valuation exist, there are only three that I find useful.”
“For a going concern, the Net present value would be most applicable. A frequently used but flawed shortcut method of valuing a going concern is known as private-market value”.
The net present value is to discount all future expected cash flows to the present to obtain the intrinsic value of the company, and hence its stock, or what we call the discount cash flows analysis (DCFA).
“A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.”
How else should we invest if not this way, to know the value of something before we think of paying a price for it? This is the very essence of fundamental value investing.
“Once you adopt a value-investment strategy, any other investment behavior starts to seem like gambling.”
Seth also talked about the behaviour of most market players here:
“Few are willing and able to devote sufficient time and effort to become value investors, and only a fraction of those have the proper mind-set to succeed.”
This is also from my experience of coaching on fundamental value investing in my online courses. Many of them started with great enthusiasms which die off quickly, because of family and work commitment, or unwillingness to spend some time on this very important aspect of one’s personal finance.
Seth mentioned that “Attempting to outperform the market in the short term is futile.” He advocates on investing for the middle and long-term, same as what Warren Buffet advocates.
One of the biggest, if not the biggest risks in investing, is human behavior. Overconfidence and over optimism are inevitable elements of the human condition. Seth warns investors to be careful out there.
“Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.”
This is a warning Seth gives to investors thinking about the peril of margin financing when broker can force sell your stocks without having to give you a reason when the stock or market tanks:
“The trick of successful investors is to sell when they want to, not when they have to.”
Howard Marks
Howard Marks co-founded Oaktree Capital Management specializing on high-yield bonds, distressed debt, and private equity. According to Bloomberg, ”Oaktree’s 17 distressed-debt funds have averaged annual gains of 19 percent after fees for the past 22 years — about 7 percentage points better than its peers”.
In the 2011 Forbes rankings of the wealthiest Americans, Marks was ranked the #273 richest in the United States, with a net worth of $1.87 billion as at to date.
He is known in the investment community for his "Oaktree memos" to clients which detail investment strategies and insight into the economy, and in 2011 he published the book The Most Important Thing: Uncommon Sense for the Thoughtful Investor.
Here is what Buffett has to say about Marks’s memos – “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something…”
Like most truly super investors, Howard is a modest, humble person filled with humility. Although he is a very rich man and has done very well in his funds, he used to say the market is uncertain and unknowable. He always emphasizes that investing is not easy.
“I keep going back to what Charlie Munger said to me, which is none of this is easy, and anybody who thinks it is easy is stupid. It is just not easy. There are many layers to this, and you just have to think well.”
Since I started to “advertise” my online courses in i3investor, a number of young people, after reading how some investors making big money in the stock market using borrowed money is so easy, asked me whether they should quit their job, discard their business, and go into full time investing. I have never encouraged them to do. Instead, I always ask them to read my article in the link below:
It is summarized here:
- Utilize your human capital. Get a job and career of what you are trained for. That income is most dependable.
- Spend within your mean
- Safe and invest and utilize the 8th wonder of the world in compounding
- Avoid bad leverage, margin financing in stock investing in particular, like a plague.
- Spend time and effort to learn the fundamentals of investing, one the most important things for your personal finance.
It appears that few, or even none liked to hear what I have said and sincerely believe in.
There is no “sure-win” investing method in a jungle out there. Marks said as it is not easy to invest, and Hence “Return expectations must be reasonable. Anything else will get you into trouble, usually through the acceptance of greater risk than is perceived.”
I have borrowed his wisdom and have written a couple of articles in i3investor, and the latest is here:
“Leverage magnifies outcomes, but doesn’t add value.”
Just like Warren Buffett, Seth Klarman, and Howard Marks discourage using borrowed money to invest. They focus on limiting the downside; recognize, understand and avoid high risks as much as possible.
“Trying to avoid losses is more important than striving for great investment success. The latter can be achieved some of the time, but the occasional failure may be crippling. The former can be done more often and more dependably….and with consequences when it fails that are more tolerable.”
One way to avoid high risk is to know and understand the price-value relationship in investment.
“For investing to be reliably successful, an accurate estimate of intrinsic value is the indispensable starting point. Without it, any hope for consistent success as an investor is just that: hope.”
Yes, investing by listening to rumours, or buying stocks touted in investment forums, especially when the prices have gone up high, hoping to gain from the greater fool theory is just hope, and hope is not an investing strategy.
“Investment success doesn’t come from “buying good things,” but rather from “buying things well.”
Like many other super investors, Marks doesn’t try to predict too much into the future, for example the macro-economic thingy, or paying too much for high growth expectation. He prefers value rather than growth investing as the former is undoubtedly, more dependable.
“Growth investing represents a bet on company performance that may or may not materialize in the future, while value investing is based primarily on analysis of a company’s current worth.”
“We can make excellent investment decisions on the basis of present observations, with no need to make guesses about the future.”
"Value investing" - is supposed to be about buying based on the present value of assets, rather than conjecture about profit growth in the far-off future.
Marks expounded the concept of Second-level thinking. First-level thinkers look for simple formulas and easy answers. Second-level thinkers know that success in investing is the antithesis of simple.
Second-level thinkers know that, to achieve superior results, they have to have an edge in either information or analysis, or both. They are on the alert for instances of misperception.
First-level thinker thinks, “This is a high growth company, must buy. Use margin finance to buy to win big”
Second-level thinker,
- “Is the growth value enhancing, or value destroying”
- If it is value enhancing, has the price been factored in?
- What is my downside if I am wrong?
- What is the upside if I aright?
- What is the expected value from probability analysis based on (3) and (4) above?
- How is the expected value compared to the price?
- What if the outcome turns against you, in big time?
- What is the motive of that buy call?
- Etc.
Yes, investing is not easy. Even Charles Munger and Howard Marks say so.
Conclusions
Many successful super investors defer in their investing strategies. However, they do have some common core values and principles. They recognise that investing is not easy and hence most exhibit humility. They all shun leverage like a plague. They all care about the downside and take care of it, and let the upside to take care of itself.
Super investors invest like a businessman. They focus on long-term, not the next quarter, or the next year. They know what Howard Marks means here:
“That’s because in the world of investing, being correct about something isn’t at all synonymous with being proved correct right away.” Howard Marks
All super investors are Second-level thinker; they don’t just buy good companies, but try to buy them cheap. Goodness is measured by the return on capitals, good cash flows, not earnings, or growth in earnings. In order to know if they are cheap, they have an estimate of their values, often using the discount future cash flows analysis, or better comparable, rather than the simplistic and problematic PE ratio. They like to buy when there is a wide margin of safety between the price and the estimated intrinsic value of the stocks.
Understand the core principles of super investors are pre-requisite for the success in investing. After that, prospective investors should have the knowledge of how to carry out the strategies and methodologies following those core principles.
My personal experience in investing in Bursa has been proven that these core principles work very well for me as shown from the return of my portfolios as explained.
For those who are interested to learn the implementation of these core principles to build long-term wealth in equity investment, please contact me for an online course for a small fee at
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