By John Huber
The new year is the
perfect time to create a list of quality companies
“It is the basics. It is focusing on
selection, low prices and reliable, convenient, fast delivery. It’s the
cumulative effect of having this approach for 14 years. I always tell people,
if we have a good quarter, it’s because of the work we did three, four and five
years ago. It’s not because we did a good job this quarter.” – Jeff Bezos, 2009
The new year is always a good time to review your
investment process. The other day, I read a post on Nate Tobik’s Oddball Stocks that
makes a great point about “practicing” – basically stop trying to read
everything under the sun and get out there and actually start investing
– start valuing companies, make investments, learn, repeat, etc.
This post got me thinking because I read a lot. My
favorite part of investing is the reading, thinking and strategic aspects of
portfolio management. I much prefer the strategic aspects (i.e., analysis,
research, critical thinking) of the investment business over the executional
aspects (i.e., making the actual trades and other administrative requirements).
I prefer reading over just about any other investing activity although I have
more and more begun to appreciate the information and perspective you can get
by talking to people – scuttlebutt.
Anyhow, that’s a separate post. But I completely agree
with Tobik's point – practice is the best way to get better.
Procedural memory
A concert pianist gains proficiency at his or her
craft by developing procedural memory – doing the same thing over and over
again. You can’t learn to play Rachmaninoff by reading a book.
For years, Phil Mickelson had the best short game in
golf. His incredible talent was a necessary, but not a sufficient, condition
for his success – he got to be the best greenside player because his dad
built him a green in his backyard as a kid, and Mickelson hit shot after shot
after shot onto this green at a very young age. Mickelson’s chip shot on the
72nd hole that won him the 2005 PGA Championship was one that he said he had
practiced “tens of thousands of times”
as a kid.
Whether you’re playing the piano, hitting a sand
wedge, shooting a jump shot, riding a bike or even driving a car– the way
you learn is through repetition. The same can be said for valuation. Reading
books is fine, doing case studies is better, but actually valuing companies and
making investments– practicing– is the best way to learn.
Developing a process
As regular readers of my blog have probably gathered,
I am focused on developing processes. I’ve always felt that a process-oriented
approach to investing is one that will give you the best chance of being able
to produce success over long periods of time. Investing is a long-term game. To
produce superior results over long periods, you need a process that is replicable.
One of the centerpieces of my investment philosophy is
to only invest in my very best ideas. I don’t find lots of great investment
ideas on a frequent basis. Because I have a high hurdle rate and because what I
am looking for is not available every day (quality businesses at cheap prices),
I tend to make larger, more infrequent investments. There aren’t that many
great ideas. So in order to find these good investment ideas, you need a
system.
Focus on process, not outcomes
I try to focus on implementing investment processes
because I find it more productive to focus on processes than to focus on
outcomes. This is especially true for investing. Your investment results are
due to work and effort that has been accumulating for years. Warren Buffett was
reading Bank of America (NYSE:BAC) reports for decades before ever
buying a share. The work that I am doing today is not going to pay off
tomorrow. It is going to pay off at some unknown time in the future.
Also, you rarely can attribute investment results to
any one specific action. It’s usually a confluence of factors that come
together over multiple investment events and multiple time periods that
collectively produce results. Yesterday I read Disney’s (NYSE:DIS) 10-k and recorded some notes, I read
the Wall Street Journal, and I talked to a few users of a product made by
another company I’m researching. I have no idea if, how or when any of these
specific work activities will produce a result. I just know that, if I continue
to focus on my process, I give myself the best chance of achieving the
long-term results I’m looking for.
Wells Fargo: Process focused
My investment process has some similarities with the
companies in which I prefer to invest. My investment strategy puts an emphasis
on durable companies that have predictable earning power.
The stocks I buy come in all shapes and sizes, but one
large well-known example is Wells Fargo(NYSE:WFC). As I wrote when I mentioned the bank
warrants in a post a few weeks ago, there isn’t much that is
more predictable than the deposit growth in the U.S. banking system. Wells
Fargo is extremely well positioned to continuously capitalize on that
predictability.
It has a process– a relatively simple business
strategy– that can be replicated over and over. It takes in a consistent
share of a steadily growing deposit base, lends out or invests these funds at
higher rates and spreads operating costs over a large nationwide branch
network. It tries hard not to do dumb things (easier said than done in the land
of big banking). Focusing on its process has led to very predictable results
over the long term for the company and its shareholders.
Get better each day
As an investor, I am constantly trying to improve. One
thing a cross-country coach of mine used to often repeat is: “Try to get better
today.” Running is a sport that I competed in at the high school and collegiate
levels. Long-distance running has a lot of parallels with investing. You can’t
wake up on race day and expect to force a great performance. The performance
will depend on stringing together many months/years of daily runs– one
mile after another. None of the miles will stand out much individually, but they
collectively add up to produce a result.
I am using the new year as an excuse to refine and
refocus my process, which I’m always trying to improve. I read the newspaper
each day, but this year I am going to make it more routine and more deliberate.
I’ll make notes and keep them in a file. I also will be focusing on writing
more about individual ideas. I do a huge amount of research on companies that I
end up either investing in or putting on a watchlist. I have found (and others
have, too, I think) that writing improves comprehension and helps you retain
more information. It clarifies your thinking. Basically, a short summary might
help you wring more comprehension out of a given unit of effort. I keep a Word
doc with hundreds of pages of notes per year on investment ideas, but they are
mostly scratch notes. By organizing these notes, I hope to get a better
understanding of the business and also have a file to look back on later.
Building a list of great businesses
Also, I am going to embark on a miniproject next week
where I am going to go through all 3,500 stocks in Value Line one by one to
come up with a watchlist to study. I already have a watchlist of businesses I
follow, but I am going to create a “best companies” file on a Google sheet that
will come from this project. I haven’t finalized exactly how I will do this
yet, but my first idea is to go through the list and input all the companies
that I think I can reasonably understand (which will narrow the list
significantly). Then, I will refine it one more time by trying to pick out the
best businesses from this list, as measured by the attractiveness of their
economics and their historical financial results (consistent earning power,
stable margins, high ROICs, growth, etc.).
My hope is to build a fresh list of maybe 50 to 75
durable companies that are compounding their intrinsic values at high rates.
These are the horses you want to bet on over time. Some of these might be very
small, and others will be large. I think this will complement my current watchlist
of businesses that I follow closely. And I might even find a few bargains by
turning the pages as well. I plan to report back on this effort on the blog.
Feel free to comment on your own ideas for processes.
These aren’t unique ideas. In fact, if I remember
correctly, I got the idea of building a “best companies” list by going through
Value Line from something Stan Perlmeter (an original “Superinvestor”) did
a long time ago. It doesn’t have to be Value Line. The point is I think that
it’s a useful process to build a list of great companies. Then go through one
by one and value them– determine if they are, in fact, great. Read about
them and write down findings; this will hopefully lay the foundation for a few
great investments at some point. There is a lot of value in this process.
None of this is original. Everyone talks about
watchlists, processes, etc. And much of this I already do. I’m deliberately
writing down my process this year, but I already am process oriented. I’m just
using the new year as a way to get refocused on taking these concepts and
diligently implementing them in my day-to-day work.
Focusing on a process is much more important than
focusing on a result. As Bezos said, a “good quarter” is the result of things
they did three to five years ago. The same can be said for investing.
Happy New Year!
John
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About the author:
John Huber
I am the Portfolio Manager at Saber Capital Management, LLC. Saber manages
an investment partnership as well as separately managed accounts for clients
interested in a focused value investing strategy. My investment style has been
most influenced by Ben Graham, Walter Schloss, Warren Buffett, and Joel
Greenblatt. I am also the author of www.BaseHitInvesting.com, a value investing
blog.
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