Q. How has running a business has helped you identify bargains?
A. Without actual experience running a business, financial statements are little more than numbers on a page — data to be extrapolated into the future. After running a business for a while, you begin to see what numbers and footnotes may be critical, and which ones may be nonsense when it comes to the health of the business. The numbers eventually come to life, and then the business comes to life.
We recently invested in a Ben Graham-style net-net — a company selling below its quick liquidation value. The financial statements say that the business is bleeding money, but from a business standpoint — taking out all of the non-cash and non-recurring items, it’s actually doing quite well. A spreadsheet or stock screener can’t tell you that.
Furthermore, you have to realize that the analysts have no experience running a business. They’re looking at the same spreadsheets and stock screeners as everyone else. They’re not even reading the annual reports. Armed with some business experience, a willingness to read and learn, and the knowledge that the “majority” are not actually thinking, a deep value investor should be able to find some amazing bargains regardless of where the markets are, or are going.
Q. How do you look at risk?
A. The number one risk that I think that people assume is overpayment risk — the risk assumed when you pay too much and receive little to no value. For example, anyone purchasing General Motors’ stock from 2005 through its bankruptcy in 2009 assumed a great degree of overpayment risk. GM was worthless as a company; so, any price paid was too much. Now, Nobel laureates will tell you about the Sharpe ratios, beta, and other measures of “risk;” but, at the end of the day, the company was worthless and it was a matter of time (at least four years) before the stock price followed the value of the company.
A purchaser of GM’s stock over the past four years was not assuming risk because the stock price was volatile or because the economy was faltering. The investor simply paid too much for a worthless company. Some people got out with a profit; some lost a considerable amount. They all paid too much, and their results were either lucky (gains or minimal losses) or predictable (total losses).
Risk in investing can be minimized by demanding a large margin between the price of your positions and their intrinsic values. The greater the margin, the less risk you assume. Calculating that margin is both crucial and difficult; however, doing so allows an investor to see “risk” in a whole new light.