Read literally, the header is misleading: I am more a value investor than any other sort. But I place little credence on the historical superiority of value investing, and I am a reluctant member of the value club.
It’s not quite that I don’t want to be a member of any club which will have me; rather it’s that that I feel uncomfortable about a club which is now so crowded and where all the members think alike.
The problem with value investing is that it is now a popular and widely followed investment philosophy. Analytical techniques which historically worked well when used by a minority of investors will work less well as more investors use them. This is inherent to the nature of markets: a matter of arithmetic, not opinion.
The misleading header is useful if read as a prompt or provocation – are there some ways in which my thinking differs from most value investors? Here are a few.
Scepticism about intrinsic value
Many value investors place great stress on the concept of intrinsic value – the discounted future cashflows of a company, as distinct from its book value, liquidation value or market value.
As I explained in a previous post, I seldom write down an estimate of intrinsic value. I think mainly in terms of heuristics: P/E ratios, dividend yield, price/sales and so on, and also non-financial heuristics such as affinity (patterns of previous associations of the management and advisors to a company); and also the following convention.
Using the Keynesian convention
By “Keynesian convention” I mean the observation in Chapter 12 of Keynes’ General Theory that financial markets operate under a convention that “the existing state of affairs will continue indefinitely, except insofar as we have specific reasons to expect a change.”
In other words, we expect prices tomorrow and next month and next year to be unchanged (in real terms) from prices today, except where there is new information. So if I expect some future change in state when other investors don’t, I can buy at current prices and wait for the change of state, without thinking much about intrinsic valuation.
If the current price is already far above intrinsic value – in other words the price is already a bubble – then this approach can lead to trouble. Implicitly, I do look out for and avoid situations where this might be the case. But my main focus is on looking for early indications of a knowable future change in state, rather than on intrinsic valuation in the current state.
This mode of thinking is particularly helpful for highly cyclical businesses such as shipping and house-building. High cyclicality makes discounted cash flow valuations very difficult, so it may be better not to think about them at all. Better to look for early indications of change in state, such as freight rates or housing starts increasing.
Scepticism about deep research
I generally do not want to read 20 years of past accounts, visit factories, or conduct interviews with customers, competitors and suppliers. I don’t deny that such deep research can further your understanding of a company, but I think it is subject to strongly diminishing returns. After a certain point, deeper research doesn’t make the risk sufficiently smaller. Rather than looking deeper and deeper into one investment (and usually, convincing yourself to buy more and more of it), it is better to spend the time looking more broadly for new investments.
Small bets on large discrepancies, superficially understood
When I find a price which seems very wrong, I often prefer to make a small bet without fully researching and understanding the company. Although I might do deeper research later, the price often corrects before I do. This is fine – I just sell and go on to the next one. By keeping positions small I keep them easy to sell, that is I preserve options to change my mind as prices and my expectations change.
In other words: in a noisy information environment with more choices than I can process, I prefer to spend time looking for new large and obvious discrepancies, rather than refining my understanding of discrepancies I’ve already found. I aim to maximise the quality of my whole portfolio of insights, not my depth of insight on any particular companies.
Willingness to look silly
I actively look for investment ideas which are likely to seem silly, embarrassing or trivial to those who think of themselves as “serious” investors (e.g. value investors!). This doesn’t necessarily mean that the investment is a good one, but it does mean that few “serious” investors will be looking. One example is ASOS under 5p in 2003 – “a no-name start-up website selling teenage fashion?!” (I actually bought ASOS in 2003, but sold far too early. The current price is above £40).
I also look for risks with the following characteristic: if the bad outcome materialises, it will seem obvious with hindsight, making those who took the risk look foolish. Again this doesn’t necessarily mean the risk is a good one, but it does mean that professional investors with career concerns will not be looking.
Avoiding the three R’s
Aswath Damodaran satirises value investors with three R’s: rigid, righteous, and ritualistic. Rigid, because they have firm views and rules about analytical techniques or preferred investment sectors (albeit the rules are different for different value investors). Righteous, because they believe theirs is the only true creed, and that success with other techniques is in some sense inferior or illegitimate. Ritualistic, because they see value investment education as a sequence of sacred rites: read The Intelligent Investor, read Security Analysis, read all of Buffett’s shareholder letters, attend a Berkshire Hathaway annual meeting, etc. I have followed many of these rites, and I don’t deny their usefulness; but I try not to be too reverent (a fourth “R”!) about them.
Those are some of the ways in which I believe my thinking differs from most value investors. A difficulty with this exercise is that it’s hard to distinguish useful differences from capricious contrarianism or mere idleness. Some of the points above could be characterised as reflecting my lack of diligence. Although I worry about this, I don’t think diligence is an end in itself. My aim is to maximise long-term growth, not to demonstrate my diligence or fidelity to the value creed.