Investment Wisdom - Sam Zell style

I enjoy reading books about the world's greatest investors, particularly autobiographies. Usually I find I learn something new, discover a different angle to investing or rekindle an interesting past idea. And I find so many common threads that run through the thinking and processes employed by the Investment Masters. 

Prompted by recommendations from some of my clients, as well as one of the Investment Masters, I just finished reading Sam's Zell's autobiography, "Am I being too Subtle".

Sam Zell is a self-made American billionaire businessman and investor whose nickname the 'grave dancer' originates from his highly profitable large scale property acquisitions after the commercial property crash of the mid-1970s.

I've known of Sam Zell for the last couple of decades and have enjoyed listening to his speeches at various global property conferences during the early days of property securitisation - what was the beginnings of today's global REIT market.

I'll never forget the day the Blackstone Group bid for his listed company Equity Office Properties [EOP]. It was early 2007, and despite our REIT research team's best efforts to convince me otherwise,  I was bearish on the REIT market at the time. The morning the bid became public our REIT analyst exclaimed "I told you property was cheap, Blackstone have bid for EOP," to which I responded, "They don't call him the 'grave dancer' for nothing." Needless to say, Sam Zell came out on top in that transaction, as it was only a matter of months before the Global Financial Crisis was upon us.

The book, 'Am I being too Subtle' details how the EOP transaction unfolded and why Sam sold.  The offer was too good to refuse, "A Godfather Offer" as Sam called it. 

The book is an engaging read which details Sam's early childhood, his parent's brave escape from the Nazi's in Poland and the devastation that wreaked havoc on the family that remained. His parent's escape from Poland and his early upbringing in Chicago had a deep influence on his philosophy and outlook. 

The book takes the reader on a journey through Sam's positive and not-so positive investments. It serves as a useful guide to successful investing. Sam Zell comes across as a highly likeable, open-minded, hard working and opportunistic investor who searches beyond conventional wisdom for ideas.

I've included some of my favourite quotes from the book below.  Not surprisingly, I've unearthed almost fifty quotes that parallel with the 100 tutorials in the Investment Masters Class. There are, after all, many commonalities between the world's most successful investors.

"Conventional wisdom is nothing to me but a reference point. In fact, I believe it can be a horribly debilitating concept."

"I have an insatiable curiosity, and as a kid I thrived on wandering around my Chicago neighborhood on my own."

"I spend almost my entire day listening to other people, I ask questions, I probe, I raise possibilities."

"I am a voracious consumer of information."

"I look for clarity, and if something's not clear, I get more information."

"Think beyond the norm."

"I don't make assumptions."

"Reputation is your most important asset."

"Everything I've done has been because I've loved doing it."

"I fully realized the value of tenacity. I just had to assume there was a way through any obstacle, and then I'd find it. This is perhaps my most fundamental principle of entrepreneurialism, and to success in general."

"My focus is always on the downside."

"Liquidity equals value."

"I realized that the basics of business are straightforward. It's largely about risk. If you've got a big downside and a small upside run the other way. If you got a big upside and a small downside, do the deal."

"I rely on a macro perspective to identify opportunities and make better decisions."

"Where there is scarcity, price is no object. This basic tenet of supply and demand would later become a governing principle of my investment knowledge."

"I often went back - and still do - to what was written up there on the blackboard when I first walked into Econ 101: Supply and Demand. In fact, much of my career has been about understanding and acting on this basic tenet - whether it's in real estate, oil and gas, manufacturing, or whatever. Opportunity is very often embedded in the imbalance between supply and demand. It could be rising demand against flat or diminishing supply, or flat demand against shrinking supply."

"There's no substitute for limited competition. You can be a genius, but if there's lots of competition, it won't matter. I've spent my career trying to avoid it's destructive consequences."

"The exponential value of scale would influence my assessment of investment opportunities - in and outside of real estate - throughout my career."

"I like to invest below replacement cost, thereby creating a competitive advantage."

"Replacement cost mattered more to me than rents or comparable prices or vacancies or economic growth or stock price. This was because replacement cost determined the price of future competition."

"We liked asset-intensive investments because if the world ended, there would be something to liquidate."

"Jay [Pritzker] taught me to use simplicity as a strategy. He had an uncanny ability to grasp an extremely complex situation and immediately locate the weakness. He says that if there were twelve steps in a deal, the whole thing depended on just one of them. The others would work themselves out or were less important. He had a laser focus on risk."

"To me risk-taking rests on the ability to see all the variables and then identify the ones that will make or break you."

"Some of the best deals of course, are the ones you don't do.”

"Among my most salient takeaways was the value of optionality."

"I have always believed that every day you choose to hold an asset, you are also choosing to buy it."

"Sentimentality about an asset leads to a lack of discipline."

"I am industry agnostic."

"No matter how much time you put into addressing risk, sometimes there are unforeseen events that blindside you."

"Being global, if not in business then in mind-set, isn't really a choice, in my opinion. It's a mandate, a responsibility, and a thrill."

"I've always believed in buying into in-place demand rather than trying to create it."

"As a risk-taker my greatest fear is not having information that might protect me from making a mistake. The only way I can do that is to create an atmosphere where there are no silos."

"I'm a great believer in aligned interests, skin in the game."

"Trying to be right 100% of the time leads to paralysis."

"You can never be truly successful unless you give to others."

It's time to invest, 'grave dancer' style ....

The Keys To Successful Equity Investments

Francois Rochon initially graduated as an electrical engineer, but he quickly developed a passion for investing when he came across the book 'One up on Wall Street' by Peter Lynch in 1992.  From this book he became interested in Warren Buffett, 'the greatest investor of all', in Peter Lynch's words.  Francois started managing his own money the next year and by 1996 he had left the engineering profession to work at a mutual fund.  Two years later, in 1998 he left to start Giverny Capital which focuses on 'owning outstanding companies for the long term'.

Mr Rochon's US portfolio has compounded at an average rate of 14.8% pa since 1993 versus 9.2% pa for the S&P500. The 5.6% out-performance over such a period has a large impact on returns, with a $100,000 investment in Mr Rochon's portfolio in July 1993 worth $2.6m as at December 2016 whereas if it were invested in the S&P500 it would be worth just $790,000.

I've always enjoyed reading Mr Rochon's investment letters which are available on the Giverny Capital website.   Giverny Capital has produced a paper titled "The Keys to Successful Investing" which contains eight keys which could help you in increasing your likelihood of success.  

Many of these are common to the Investment Masters.  The links provided in the key topics below connect to the relevant Investment Masters Class Tutorials.

1) Consider stocks as fractional ownership in real businesses

"When we study the great masters of investing and the many decades of available data, we find  a critical point in common: these investors behave like businessmen. When they buy a company’s stock, they first and foremost are buying part of an enterprise. Whether they are purchasing a hundred shares of Johnson & Johnson or several million  shares, these investors consider it no  different than if they were buying the company in its entirety."

2) Being present

"One of the flaws of many investors in trying to play the market is to attempt to time the market.  To experience returns on the markets, one must first and foremost be present with the market. "

3) Profit from market fluctuations rather than suffer from them

"The  metaphor  of  “Mr.  Market”,  as  taught  by  Warren  Buffett’s  mentor  Benjamin  Graham, illustrates the attitude that the rational investor must adopt when facing the market. In fact, the irrational attitude of Mr. Market is the source of investment opportunities for the investor who knows how  to stay rational and unemotional. This investor knows that stock market prices will reflect the fair value of the underlying enterprise in the long term. So, from this perspective, market fluctuations are your allies and not a source of suffering. "

4) Leaving yourself a margin of safety

"The concept of “margin of safety” is borrowed from the world of engineering. When an engineer is building a bridge that  has a capacity to support a five-ton truck, he will build it so that it can support a truck of eight or ten tons. This represents a margin of safety. When we use this concept within the context of investing in a company’s stock, it is the difference between what we think the company is worth versus the value of its stock price.   

The starting point is the intrinsic value of the company, which we determine theoretically by calculating the current value of the future cash flows generated by the company over the course of its life. Since this is a highly subjective analysis, we must consider a wide margin of error.    

The more the market is irrational about the value of a company during a selloff, the lower the  price we can pay for the company’s shares, thus increasing our margin of safety. 

Furthermore, one should consider that the margin of safety also exists with more qualitative factors as well. For example, the quality of the company’s management team, its competitive  advantages, and its intellectual property to name a few. Finding solid companies at attractive prices is the keystone to our approach.  

5) Stay within your circle of competence

"When it comes to selecting businesses to invest in, Warren Buffett is guided by what he calls his “circle of competence”. What is critically important, he says, is to know the limits of your circle  of competence.   For example, if you don’t know the difference between the atomic number of
Titanium and the one for Uranium, you should probably steer clear of this sector.  
 
To wander outside of your circle of competence significantly increases your probably of making a poor decision.  In the market, to realize better returns than others, you must have better knowledge regarding the value of the businesses in which you invest (the others are the market).  

To succeed, it is important to stay close to companies that one can understand well and evaluate well."

6) Know when to sell

"Philip Fisher, the famous investor, once said: “if you’ve done your work well when you’re  buying,  the time to sell is... almost  never”. Ideally, we would love to keep our outstanding companies forever, but life is not ideal and a realistic approach is necessary. 

We believe that the reasons for selling a stock should be harmonized with the reasons for buying it. We should consider selling if these reasons are no longer valid. In other words, once the investor becomes aware that he made an error in his analysis or the prospects of the business have deteriorated, it is the time to sell. Our firm evolves and companies evolve just as much, for better or for worse. Our investment approach must be aligned to the nature of the capitalist world within which it participates.   

Another more pragmatic reason for selling is that the majority of investors do not have unlimited sources of capital at their disposal and they may, quite simply, sell in order to invest in another company whose potential seems brighter. "

7) Learn from your mistakes

"Mistakes are inevitable in the investing world.  The key is to recognize them quickly and learn from them.  There are two categories of mistakes: mistakes of commission and mistakes of omission.  The first consists of failing in what you decided to buy, whereas the second consists of  failing to buy a stock that met all your purchasing criteria. Generally speaking, mistakes of omission are often the most costly. To miss a stock that climbed 1000% is ten times more costly than losing 90% of you  capital in a stock that did poorly. 

Other mistakes fall into the category of “psychological biases”, with anchoring and overconfidence being good examples. Anchoring is related to the fact that our human nature is such that we often remain anchored on first impressions or first data points, even when those perceptions become detached with reality.  For example, an investor bought stock ABC at $50 two years ago and it is now trading at $25 following news about the loss of a significant contract and/or lower profits. The investor remains anchored to the notion that his stock is worth $50 simply because this was the purchase price. In reality, there is no link whatsoever between the price paid for a stock and the value of the company. What matters is the future prospects of the company. 

Finally, overconfidence manifests itself often and under different forms. Its only remedy is humility."

8) A constructive attitude

What differentiates successful investors from others is not related to intelligence, but rather related to attitude.  

Warren Buffett often uses the adjective RATIONAL to describe good investors. Rational investors do not let themselves be influenced by fads or crises.  Aside from a rational attitude, another important quality (and one apparent in Warren Buffett) is the capacity to always want to learn and progress.    

The world is in a perpetual state of evolution and it is not easy to for someone to also constantly  evolve. To be in a constant state of learning, one must not only be passionate for their art, but also humble.

Without humility, there is no opening for something new. Therefore, paradoxically, successful  investors must be able to combine both a high confidence in their judgment while also remaining  constantly humble. A difficult and fragile equilibrium." 

The Truth About Investing

Howard Marks recently presented at the CFA Society in India. His presentation was titled "The Truth about Investing".  

The 40 page presentation covers the core foundations of Howard Mark's investment philosophy. For those looking for more on Howard Mark's investment thoughts I highly recommend his book "The Most Important Thing - Uncommon Sense for the Thoughtful Investor" which is in my Top 5 recommended books. The book draws on many of the investing themes that Mr Marks has written about over the years in his investment memos.  These memos are available on the Oaktree Capital Management website. Click here to to access the memo archive.  

The video from the CFA Society can be accessed below:

10 Timeless Lessons from Bernard Baruch

Known as "The Lone Wolf of Wall Street", Bernard Baruch was one of the the world's most famous speculators of the 20th Century. By the age of 30, Mr Baruch had amassed a fortune.  He went on to advise US presidents and congressional leaders from 1918 to 1948.  

His memoirs, "My Own Story", written in 1957, provides a fascinating account of Baruch's life, his insight into human psychology and the history of speculation. His first hand account of market panics, bull markets and short squeezes and the associated emotional reaction of the markets provide timeless wisdom.  

Mr Baruch lays down 10 guidelines from his lifetime of experience in the markets which he notes 'may be worth listing for those who are able to muster the necessary self discipline'. Like all of the Investment Masters there are many common threads that form the foundation of his success. With the exception of Mr Baruch's commentary on taxes, all of the 10 guidelines are tutorial topics in the Investment Masters Class.

1. Don't speculate unless you can make it a full-time job

2. Beware of barbers, beauticians, waiters - of anyone - bringing gifts of "inside" information or "tips."

3. Before you buy a security, find out everything you can about the company, its management and competitors, its earnings and possibilities for growth.

4. Don't try to buy at the bottom and sell at the top. This can't be done except by liars.

5. Learn how to take your losses quickly and cleanly. Don't expect to be right all the time. If you have made a mistake, cut your losses as quickly as possible

6. Don't buy too many different securities. Better have only a few investments which can be watched.

7. Make a periodic reappraisal of all your investments to see whether changing developments have altered their prospects.

8. Study your tax position to know when you can sell to greatest advantage.

9. Always keep a good part of your capital in a cash reserve. Never invest all your funds.

10. Don't try to be a jack of all investments. Stick to the field you know best. 

[Source: "Baruch - My Own Story" Published by Henry Holt & Co., 1958.]

Roy Neuberger and Anti-fragility

I enjoy reading biographies and autobiographies from the Investment Masters, successful business icons and interesting individuals. I recently read Roy Neuberger's "So Far, So Good - the First 94 Years". Born in 1903, Mr Neuberger was a founding partner of the investment firm Neuberger & Berman. Mr Neuberger was a mentor to Jim Rogers and counted Alfred Winslow Jones [credited with starting the first modern hedge fund] as a client. At the time of writing he had spent 68 years on Wall Street. In that time, he'd never had a down year!

While the majority of the book is devoted to his love of art, there are nuggets of investment wisdom throughout including Chapter 11 which outlines the "Ten Principles of Successful Investing."

What I find most insightful are the lessons and ideas that contribute to investment success that have remained constant over a long period of time. In the terms of Nicholas Nassim Taleb, these ideas are "anti-fragile." In his book of the same name, Taleb notes,

"If a book has been in print for forty years, I can expect it to be in print for another forty years. But, and that is the main difference, if it survives another decade, then it will be expected to be in print another fifty years. This simply, as a rule, tells you why things that have been around for a long time are not "aging" like persons, but "aging" in reverse. Every year that passes without extinction doubles the additional life expectancy.  This is an indicator of some robustness. The robustness of an item is proportional to its life!"

The Ten Principles:

1) Know Thyself - Mr Neuberger advises that before you begin studying companies for investment study yourself. Emotion is the great undoing of most investors and it's important to understand your own strengths, weakness, fears and biases.

2) Study Great Investors - Mr Neuberger advises, that while you should study the great investors, you should not follow them blindly. You must find a style that is appropriate for you. Mr Neuberger cites numerous examples (eg Warren Buffett, Ben Graham, Peter Lynch, George Soros), and all (with the exception of the private investors) feature prominently in the Investment Masters Tutorials.

3) Beware of the Sheep Market - Mr Neuberger recommends not falling in with the crowd. He cites the importance of doing your own research and choosing stocks based on merit not crowd behaviour.

4) Keep a Long Term Perspective - while the Wall Street community appears to be obsessed with finding out what is happening to corporate earnings from minute to minute, Mr Neuberger recommends keeping a long-term perspective. This is a common trait amongst the Investment Masters and is commonly referred to as "time arbitrage". He recommends four criteria that stand the test of time (1) a good product (2) a necessary product (3) honest, effective management, and (4) honest reporting.

5) Get in and out in time - timing might not be everything but it is a lot. Mr Neuberger notes timing is partly intuitive and partly contrary. He advises additional caution in bull markets and counsels to be quick getting out when you're wrong. 

6) Analyze the companies closely - Mr Neuberger recommends analysing company's management and assets. The trick is to find growth stocks before others and he warns against paying high P/E's for stocks. 

7) Don't fall in Love - Mr Neuberger highlights the need to be sceptical and flexible, not stubborn, about a stock. The last thing you want is to fall in love with a security.

8) Diversify, but don't hedge [short] - Although Mr Neuberger did indeed short stocks himself, he recommends it be done only with the help of someone experienced. He also suggests diversifying your investments.

9) Watch the environment - by environment, Mr Neuberger is referring to the general market trends as well as the world outside the market. He advocates the need to adjust to market conditions in which you are operating. He proffers watching energy supplies, auto sales, economic conditions and interest rates.

10) Don't follow the rules - Finally, Mr Neuberger suggests you find your own style, learn from your mistakes and be prepared to change.