Geoff Gannon May 16, 2022

Don’t Just “Over-Maximize” One Variable – Find Stocks That Tick a Lot of Boxes at Once

On the day of this year’s Berkshire Hathaway annual shareholder meeting, Andrew and I were in Omaha at a Willow Oak event. Willow Oak is the company that provides a lot of the administrative support functions for our fund. The event was a panel which Andrew moderated and which featured four managers of funds associated with Willow Oak. I was one of those managers. And one of the questions we were asked had to do with what we’ve learned, what we’d have done differently, etc. as investors.

My answer had to do with not “over-maximizing” a single variable when it came to stock selection. There are, of course, other things I may have learned or might wish I’d done differently. Maybe this will become a series of articles where I talk through a few of those. But, on that night, I had only the one answer: not being too focused on “over-maximizing” a single variable. So, that’s the topic we’ll tackle today.

First, what do I mean by “over-maximizing”? A stock may be clearly expensive at 24 times EBITDA, ambiguously priced at 12 times EBITDA, and clearly cheap at 6 times EBITDA. Does that mean you should like it even more at 3 times EBITDA than at 6 times EBITDA? If it’s the same business at the lower price – yes, of course. Other things equal, cheaper is better. But, other things are rarely equal. And the argument that the same business priced at 3 times EBITDA instead of 6 times EBITDA is a better buy doesn’t translate into an argument for starting with the stocks priced at 3 times EBITDA instead of looking at those priced at 6 times EBITDA. If the business is good enough, the management honest and hardworking enough, your knowledge of the industry deep enough, etc. and it’s priced at 6 times EBITDA – that’s probably enough. Often, you may be compromising more than you think on the other softer variables to maximize the hard variable of price.

This doesn’t mean I’d totally avoid stocks whose primary attraction is their price. Of stocks I talk about regularly on the podcast, two stand out as being “maximally” cheap (or, at least they were when I bought them): Vertu Motors (VTU in London), and NACCO (NC). These stocks were not just “cheap enough” on traditional value measures of price-to-book and EV/EBITDA. They were extremely cheap. Basically, they could have doubled in price and still been considered quite a bit cheaper than the average stock. Of course, that’s because they were in industries (U.K. car dealers and U.S. coal miners) where multiples were much lower than other industries.

So, my point isn’t to avoid the very low price-to-book and very low EV//EBITDA stocks. That’d be silly. There’s no reason to eliminate super cheap stocks for being too cheap and preferring only the somewhat cheap stocks. But, there is a good reason to focus on analyzing the other aspects of these companies and their industries. In the …

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