How My Investing Philosophy Has Changed Over Time

Someone over at GuruFocus asked me about my background:

Hey Geoff, I recently started listening to some of the audio recordings you posted. You are really knowledgeable, what is your background? 

My educational background is that I am a high school dropout. My investing background is that I got interested investing when I bought my first stock at 14. That’s when I read Ben Graham’s Security Analysis and The Intelligent Investor.

My Investing Approach Has Drifted From Graham Toward Buffett

Over time, based on my own investing results, I probably became less of a Graham type investor and more of a Buffett type investor.

I made the most money by far buying and holding companies with strong competitive positions when they were temporarily priced at 6 or 10 or 12 times earnings. I also buy net-nets, net cash bargains, etc. But generally I like a reliable business with almost no history of losses and a market leading position in its niche. That’s probably more Buffett than Graham.

Hidden Champions of the 21^st Century is My Favorite Book  

My favorite book is: “Hidden Champions of the 21^st Century.”

Technically, it’s a business book – not an investing book. But business books are almost always more informative for investors than finance type books.

If I had to hand 3 books to someone who didn’t know anything about what it takes to be an investor – I’d hand him:

1. You Can Be a Stock Market Genius
2. The Intelligent Investor (1949)
3. Hidden Champions of the 21^st Century

If you aren’t in love with the idea of the treasure hunt after reading those 3 books – I don’t think you’ll ever become a value investor.

All I Really Know – Compounding, Mr. Market, Margin of Safety, Moats

If you know:

• The Berkshire/Teledyne stories
• Ben Graham’s Mr. Market Metaphor
• His margin of safety principle
• And you’ve read “Hidden Champions of the 21^st Century”

You have everything you need to make money snowball in the stock market.

All It Really Takes – Patience, Common Sense, and a Few Sound Principles

My feeling is – and it’s controversial, but it’s right – that if you’ve got those 4 ideas in your head and once a year you buy the very best stock you can and then you forget you own it for at least the next 3 years, you’re gonna do okay in the stock market.

You don’t need to know if you should be 100% in stocks or 100% in bonds – I was 100% in stocks when the dot-com bubble burst – and I’ve made more than 15% a year returns since then.

Most of the Advanced Concepts Are a Distraction – Forget Them

Now, true, I didn’t own any tech in 2000. I owned companies in groceries, snack foods, and video games. But that’s not because I was clairvoyant. It’s because I was a kid. I didn’t know any better. Over …

Can You Screen For Shareholder Composition? – 30 Strange Stocks

Nate Tobik has a terrific blog post about shareholder composition over at Oddball Stocks called “Could Value Investors Be the Reason a Stock’s Cheap?”

I’ve often found companies with unusual shareholder composition to be interesting opportunities. That’s not exactly the point of Nate’s post. He wonders – correctly, I think – whether the sort of catalyst a value stock like George Risk (RSKIA) requires is something that gets folks other than value investors interested in the stock.

A change in the perception of what kind of stock a company is can have a huge influence on where it trades. If you look at Village Supermarket (VLGEA), it went from being a regional grocer valued at a discount to the big guys to being seen as a predictable stalwart of sorts. The increase in the ratio of price-to-earnings, price-to-book, and price-to-sales has been magical. The business has improved. But then Mr. Market has also valued improvement in the business at about 3 times more than he did just 10 to 15 years ago.

Who Owns a Stock Matters

I think shareholder composition often helps explain why a stock is cheap. However, it’s not always just a matter of whether the folks who own the stock are value investors, growth investors, etc.

Shares Are Sometimes Spread Around in Weird Ways

Sometimes – like at Solitron Devices (SODI) – shareholders are former creditors.

I read a recent blog post where someone had commented wondering why Solitron is a public company. That’s easy. Solitron was once a big public company. It went bankrupt. It just never went private.

The company you see today bears little resemblance to the company that went public. Instead, it’s the company that emerged from bankruptcy in the 1990s.

Other times, shareholders have become “lost” over the years. They’ve forgotten they own the stock. And they don’t trade it. This was the situation at George Risk.

And George Risk has made a point in its SEC filings of saying that paying a dividend on the stock helped remind “lost” shareholders about the stock – and helped them get these shareholders to offer shares on the open market. Where the company is a buyer of its own shares.

I once read an interview with the CEO of a family controlled, thinly traded bank. When asked why the company went public he said they wanted local businessmen to have a stake in the bank. They went public as something of a local PR ploy.

Warren Buffett Made Money on Stocks With Oddly Distributed Shares

Two of Warren Buffett’s big successes – National American Fire Insurance and Blue Chip Stamps – were stocks with very oddly distributed shares.

Warren Buffett and National American Fire Insurance

I told the story of National American Fire Insurance in “How Warren Buffett Made His First $100,000”:

This company was controlled by Howard Ahmanson. It’s a strange story. The original stock was pretty much worthless. It ended up being …

Notes on Warren Buffett’s 2011 Letter to Shareholders

You can read my thoughts here.

Talk to Geoff about Warren Buffett’s 2011 Letter to Shareholders…

What to Look for in Japanese Net-Nets

Someone who reads the blog sent me an email asking about a specific Japanese net-net. Rather than trying to choose the best net-nets from among the entire hoard in Japan, I would suggest doing one of two things:

1. Bigger investors can simply collect all the Japanese net-nets they find. 
2. Smaller investors can simply apply a tougher standard than mere net-netness.

In my own portfolio, I went with option #2. I bought 5 Japanese net cash stocks last year. I’ve since sold one of them. I have some cash. And am looking to add a couple more Japanese net cash stocks. Right now, they make up 30% of my portfolio. Again, I’m willing to go as high as 50% in Japan. We’ll see what happens.

But that’s me.

What would I suggest for others interested in Japanese stocks?

Here’s how I would look at Japan. If you can find stocks selling for less than net cash with few/no operating losses in their long-term history, buy them. Don’t so much look for net-nets in general. Start with an even higher standard. Start with profitable, net cash companies. They are close to non-existent in the U.S. But not Japan. After that, I’m not sure I would necessarily just look at net-nets. For example, there are some cheap Japanese gas companies that are not net-nets (most of their assets are PP&E) but are super reasonably priced on an EV/EBIT basis. To me, it is more important to find totally obvious bargains than to get caught up in the definition of what a net-net is or isn’t.

Totally obvious bargains fall into a few categories. Here are 2:

1. Stock market says the business is worth more dead than alive (profitable net cash stocks)
2. Stock is much cheaper than its peers around the world (gas companies)

In fact, if you really look, you may find some gas companies, grocery stores, etc. that are very cheap on an EV/EBIT or EV/EBITDA basis that you like better than some of the net-nets. That’s fine. Buy the most obvious bargains. The things that are clearly selling for less than they are worth.

If you’re only going to buy half a dozen Japanese net-nets, you should look for net cash bargains. Once we are talking about receivables, inventory, etc. you need to know more about the business. So it needs to be a simple business or a business you can learn about. That’s harder. For me personally that means it makes sense to buy net cash bargains in Japan and look for net-nets on the basis of receivables, inventory, etc. in the U.S. Because in the U.S., I have a better chance of knowing the difference between a predictable business and an unpredictable business.

If I could find 10 consistently profitable companies selling below net cash in the U.S., I wouldn’t buy any Japanese stock. Because I understand American businesses better. But I also understand that a consistently profitable company selling for less than net cash will work out as …

Working for GuruFocus

I finally made the move to Texas. And am now working full-time for GuruFocus.

Here are the articles I’ve written since joining them last week:

Can You Build a Liquid Portfolio with Illiquid Stocks?

Free Cash Flow: Adjusting for Acquisitions, Capital Allocation, And Corporate Character

What Are the Minimum Requirements for a Good Net-Net

Pain and Patience: Net-Nets, Magic Formulas, and Micro Caps

How to Read a 10-K: What is the Most Important Part?

Free Cash Flow vs. Owner Earnings: Which Matters More?

How Long Should You Hold a Net-Net?

You’ve Crunched the Numbers: Now What?

Western Digital (WDC): Ben Graham Bargain or Mispriced Bet?

Understanding an Industry: Is Simple Better than Familiar?

Are Most Net-Nets Uninvestable?

Do Working Capital Reductions Count as Free Cash Flow?

Warren Buffett’s (Modern Day) Margin of Safety

Berkshire Hathaway’s New Buys – And One Really, Really Old One

David Einhorn’s Buys: More Tech and a Return to Yahoo (YHOO)

Glenn Greenberg’s New Buys: Growth Stocks for Value Investors

What Books Should You Read About Ben Graham? 

GAAP Accounting: Restatements vs. Realities

Vistaprint (VPRT): The Makings of a Moat?

Walter Schloss: 1916 – 2012

How Do You Estimate a Stock’s Intrinsic Value?

What Stocks Would Phil Fisher Buy Today?

I also write GuruFocus’s Ben Graham Net-Net Newsletter and GuruFocus’s Buffett/Munger Bargains Newsletter.

All my writing will be done over at GuruFocus from now on. But I’ll still be on Twitter. And you can always email me.

So don’t be a stranger.

Talk to Geoff…

Variation

Someone who reads my blog sent me this email:

Geoff,

 

Reading your articles. I am confused between standard deviation and coefficient of variation. Standard deviation itself shows how much variation exists from the average then what does coefficient of variation tells us?

 

Gurpreet

Standard deviation shows the amount of variation. Not related to anything. The variation coefficient shows the relative amount of variation. The standard deviation related to the mean. You should always relate the standard deviation to the mean. Otherwise, you will think height varies a lot among NBA basketball players because they are all tall while height varies little among children because they are all short.

Standard deviation is not a number that ports well. The variation coefficient is. It’s a way of seeing how big the swings above or below the average have been in terms of the average. Have they been one-third of the average? Or have they been the same size as the average?

For example, two companies can both have a standard deviation of 10% in their operating margins over the last 10 years. If one company has an average operating margin of 10% and the other has an average operating margin of 30% – that same 10% swing is going to feel very different. The variation coefficient tells you this. The standard deviation does not.

I need to make two points here. One, I use stats to describe. Not predict. Two, I use stats to compare. To rank. Different people have different reasons for measuring the things they measure.

If your goal – like mine – is to describe the past and compare different company’s pasts to each other, the variation coefficient is the right number to use.

Talk to Geoff About Variation…

Faith in Net-Nets

My latest net-net article over at GuruFocus includes my clearest explanation of what to look for in net-nets – and more importantly – what it takes to make money investing in net-nets:

If the balance sheet is very liquid and insider ownership is very high – there’s a good chance something will happen. I have no idea what. And I have no idea when. But someday, something will happen to increase the return on those assets…Sometimes it’s as simple as returning the assets to shareholders, using net cash to make a management buyout super cheap, or using net cash to buy a totally different business…When you buy a net-net you are not buying future earnings. You are buying future assets. What I’m talking about here is asset conversion. At some point, you are expecting today’s assets will be converted into something you can profit from. Something a control investor will pay for. Or something the market will reward.

It’s very hard to imagine these events ahead of time. But you can still bet on them:

That’s the uncertainty in net-nets. Most of the best net-nets have this certain/uncertain duality. It is certain the stock is selling for less than it’s worth. It is uncertain how the stock will ever sell for what it’s worth.

Remember what Ben Graham told the U.S. Senate:

The Chairman: When you find a special situation and you decide, just for illustration, that you can buy for 10 and it is worth 30, and you take a position, and then you cannot realize it until a lot of other people decide it is worth 30, how is that process brought about – by advertising or what happens?

Mr. Graham: That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realizes it one way or another.

Talk to Geoff about Faith in Net-Nets

Check out the Newsletter…

Investor Questions Podcast: All Interviews and Episodes

Someone who reads the blog sent me this email:

Hey Geoff,

Thanks for posting up your old podcast episodes!  Any chance you can put up the interview series episodes as well?  Thanks!

-Drew

Sure. Here are links to all the interviews and episodes. Remember, they are old. So any references to stock prices, market conditions, etc. are out of date.

Interviews

Tariq Ali of Streetcapitalist (Interview/Site)

George of Fat Pitch Financials (Interview/Site)

Asif Suria of SINLetter (Interview/Site)

Jon Heller of Cheap Stocks (Interview/Site)

Toby Carlisle of Greenbackd (Interview/Site)

Episodes

Episode 1

Episode 2

Episode 3

Episode 4

Episode 5

Episode 6

Episode 7

Episode 8

Episode 9

Episode 10

Episode 11

Episode 12

Episode 13

Episode 14

Episode 15

Episode 16

Episode 17

Episode 18

Episode 19

Episode 20

Talk to Geoff About the Podcast…

3 Net-Net Articles

Here are the 3 net-net articles I’ve written over at GuruFocus:

When Is a Bad Business a Good Net-Net?

Risk in Net-Nets

How Many Net-Nets Are There?

Expect a new net-net article each Friday. The net-net newsletter comes out once a month. The next issue is set for January 6th. The newsletter picks one net-net a month. And holds each pick for one year. Starting in April, I’ll be writing about the performance of each net-net as it exits the portfolio. So you’ll get to judge the newsletter’s results for yourself.

So far they’ve been ugly. 2011 was not a good year for net-nets. At least not in the U.S.

On the bright side, it looks like one of my Japanese net-nets – Sanjo Machine Works – is going to be bought out. 

Even though Sanjo is just one-fifth of my Japanese net-net portfolio the 140% return on Sanjo will end up making 2011 a good year for the group despite my other four Japanese net-nets doing absolutely nothing pricewise.

Talk to Geoff About Net-Nets

Check out the Newsletter…