Nick’s Note: At the Daily, we want you to become better investors. That’s why I’m bringing you today’s essay from Chris Mayer. Chris is the best value investor I personally know. His proprietary investment strategy outperformed not only the S&P 500, but also legendary investors like Warren Buffett, Carl Icahn, John Paulson, and David Einhorn for 10 years straight.
Below, Chris reviews one of his favorite books. It explains why value investing is easier in theory than in practice. Following his wisdom will help you beat the markets.
By Chris Mayer, editor, Chris Mayer’s Focus
I get a lot of reading done on planes and trains. And most recently I read Richard Oldfield’s Simple But Not Easy. Oldfield is the top dog at Oldfield Partners, a London-based money management firm. His book is a kind of memoir about his experiences and the lessons learned over 40 years of investing.
This stuff is catnip for me. I’m a junkie, but even if you aren’t, you will probably enjoy this book. It’s well written and even funny in parts. And he gives some good advice.
In one of his stories, he writes about a meeting with clients where he says, “I think investing in Russia is safer than investing in Coca-Cola.” This was in May 1997. Coca-Cola, a staid blue chip, was trading for a pricey 42 earnings. Russia, which he had just spent time visiting, was full of cheap stocks with higher growth rates.
In August 1998, both the Russian stock market and currency collapsed. In U.S. dollar terms—in just a few months—the market fell by 90%.
He’s thinking at this point that his quip might haunt him as the silliest thing he’s ever said. (I can sympathize. I do a lot of public speaking and give a lot of interviews. And I can think of some things I’ve said that I wish I hadn’t.)
But mark the sequel.
From the bottom in 1998, the Russian market doubled. Then it doubled again. And again. The Russian ruble also recovered. By the end of 2005, the Russian market was 18 times what it was at the end of 1998. From May of 1997, when Oldfield made his quip, the market was worth 3.7 times more.
And Coca-Cola? Earnings grew 60% over that time. But the price-to-earnings ratio fell from 42 to 21. By the end of 2005, the stock price was 21% lower than it was in May 1997.
Lessons?
“Safety… is not an absolute term,” Oldfield writes. “It is a function both of the investor’s time horizon and of the investment’s volatility.” You should invest in stocks with a long-term horizon. I say at least a couple of years. Oldfield says five. You get the most benefit out of investing in stocks by giving them time to work.
The other point of the story is this:
Investment managers have to learn early in their career that share prices can fall precipitously… Every manager should also learn not simply to abandon ship when such a disaster occurs, but to see whether anything can be salvaged. After such a share price fall, the right answer, emotionally difficult as it is, may be go back for more.
Another anecdote I liked was how after the 1987 crash, his firm decided to hold 40% cash. They had a big-picture thesis about what the effect would be and how the world had changed.
Of course, they were completely wrong—the market recovered.
This experience leads to another good nugget: “Dogmatic large-scale views of prospects for the world, or for markets in general, are as unwise as betting all one’s chips on a single number in roulette.”
I see people put all of their chips on a single number all the time in the market. People commit to a view—like, “the market is going to crash”—and this dogmatic view causes them to miss great stocks right in front of them.
A portfolio should be more than one big idea. If you think inflation is a threat, fine, but don’t commit 100% of your portfolio to that view. You could be wrong. As an investor, you can’t afford to be dogmatic.
Oldfield had yet another good piece of advice, which made me chuckle because it’s so simple: “The only way to be sure that part of a portfolio is not exposed to equity market risk is to invest in something other than equities.”
So simple, and yet many try so hard to make stocks not behave like stocks by selling too early. They sell just because shares fall in price. They churn their account, or overly diversify, etc.
Oldfield has good words to say about concentrated portfolios. “Studies… do show a tendency to outperformance on average by those who have a concentrated portfolio consisting of their best bets, rather than before portfolios with 50 or 60 or more holdings.”
That’s one reason why we focus on our best ideas here. No one can really know 50 or 60 stocks. And is it really worthwhile to own your 60th best idea? How about your 59th best idea?
Oldfield writes well about the folly of forecasting. He dredges up some gems here… like Thomas Watson (of IBM fame) predicting, in 1943, “there is a world market for maybe five computers.” And a Western Union internal memo saying the telephone had “too many shortcomings to be seriously considered as a means of communication.”
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And there are financial forecasts gone awry, examples of which are endless. Oldfield, as usual, sums up the case against forecasting eloquently:
Why bother? This kind of record shows that reality has very little to do with forecasting… Managing money does not involve tremendous prescience. It requires the common sense to be doubtful about the flawed prescience of others.
I don’t guess about where the market is going or what the Fed is going to do. That doesn’t mean I ignore the big picture. It means I don’t rely on macro forecasts—mine or anybody else’s. Accepting that there are things we can’t know goes a long way in investing.
In the book, there are chapters you might find helpful on such topics as fees, benchmarks, what to look for in a manager, when to fire that manager, and much more. Most of the time Oldfield is just using good old common sense:
The great battle in investment is to avoid becoming more enthusiastic about something which has just done well and avoid becoming more gloomy about something which has just done badly. This is hard, because human beings like togetherness. To hold a view alone is uncomfortable. But in investment it is axiomatic that if all are enthusiastic they are wrong.
As his well-chosen title says: investing is simple, but not easy.
You can find Simple But Not Easy: An Autobiographical and Biased Book About Investing on Amazon right here.
Regards,
Chris Mayer
Editor, Chris Mayer’s Focus