Paul D. Sonkin is the Portfolio Manager of The Hummingbird Value Fund and the Tarsier Nanocap Value Fund. Paul is currently an adjunct professor at Columbia University Graduate School of Business, where he teaches courses on security analysis and value investing. He is a member of the board of several public companies including Meade Instruments Corp. He was previously a senior analyst at First Manhattan & Co., a firm that specializes in mid and large cap value investing. Before that he was an analyst and portfolio manager at Royce & Associates, the investment advisor to the Royce Funds. Royce & Associates practice small and micro cap value investing. Prior to receiving an MBA from Columbia University, he worked at Goldman Sachs & Co. and at the U.S. Securities and Exchange Commission. He is a co-author of Value Investing: From Graham to Buffett and Beyond (Wiley Finance)
Mr. Sonkin was nice enough to offer over an hour of his time for our interview. In fact he was prepared to offer even more time if I had more questions for him. It was a pleasure conducting the interview with Mr. Sonkin.
Below is our conversation:
Jacob Wolinsky: I always love asking this question to value investors. Value investing is contrary to human nature. Every value investor has a story how they got started in value investing. What was your catalyst?
Paul Sonkin: I was in the Columbia Business School and I knew I wanted to get into money management. And there was this class by someone of the name of Bruce Greenwald and they only taught it for a year and it was called Value Investing. And it must have been the first or second class where a Bruce Greenwald quoted a study that had come in 1993 by Eugene Fama and Kenneth French that small cap outperformed over time and value outperformed over time. And it was a really eppithany for me that if that is where the money is I should do small cap value.
Jacob Wolinsky: I am just curious if Fama and French are strong believers in the efficient market theory and value stocks have lower beta and are therefore “less risky” how does this conform with their theory?
Paul Sonkin: I don’t remember exactly what is, but I think there is basically a liquidity premium and you are paid to take on that risk.
Jacob Wolinsky: So basically they changed their definition of risk just to make it fit with their theory?
Paul Sonkin: Exactly, and I don’t remember if it was in that study I don’t remember exactly what the specifics were. But that is really what got my start.
There was an article in Barron’s titled The Most Patient Man on Wall Street and The Second Most Patient Man on Wall Street and they interviewed someone from First Chicago. He did a lot of pink sheet investing. The second guy was a person by the name of Ed Mcgoocklin who also did a lot of pink sheet investing. He spoke about a company called Park Lexington Corporation they owned about three buildings in New York City. I did an analysis on the company and it turned out it was cheap. I called up Ed Mcgoocklin and sent him my report and told him I had some questions for management. He flew up to New York City to meet me.
On Wednesday I went to listen to Mario Gabielli but I got the flu and I could barely walk out to get home. The meeting with Ed was on Friday and I had 104 fever but we had our meeting. He presented my report to the company and six months later the company went private at a pretty rich premium.
So I thought this is pretty cool. You can look at a company, talk to the management pretty easily and have an influence on the outcome.
I got a job working for Royce and Associates and I was on the microcap team and I was doing what I really loved doing. They were a lot smaller back then they had about $2 billion under management. Today they have something like $20 billion under management.
Jacob Wolinsky: There are many different styles in value investing ranging from Benjamin Graham’s net-nets to Warren Buffett’s purchase of companies with wide moats? What style do you must subscribe to? I assume you will have more of a Benjamin Graham style net-net approach due to the size of companies you invest in?
Paul Sonkin: If you read the book Value Investing: From Benjamin Graham to Benjamin Graham I talk about three different types of value investors: traditional value investors, value investors with a mixed approach and contemporary value investors. I consider myself to be much more of a traditional value investor looking at Benjamin Graham’s net-nets and things of that nature.
Jacob Wolinsky: So what else do you look for besides net-nets? Would that be your ideal investment?
Paul Sonkin: In the book Bruce Greenwald talks about the three traunches of value you have your asset value, your earnings value, and earnings power with growth. So we do the first two which is look at buying companies below their asset value, below book value, net-net value, working capital value etc. What your buying mostly is companies that is low priced to book stocks, companies that aren’t earning a lot of money but have a lot of assets. So they are asset rich but earnings poor. What we do is find out what is wrong with the company and understanding why their earnings are done and if they might recover.
The second company we buy is a company that is at a discount to its earnings power value. Those are the low P/E stocks. Those are companies that are trading at 5x, 7x or 10x earnings. These companies might be trading low because of a perception that their earnings will decline further in the future. What you are trying to do there is prove why the earnings will not decline in the future.
Jacob Wolinsky: You invest in micro-cap stocks. Can you give me a number of the average market capitalization of a stock you invest in?
Paul Sonkin: According to the classic definition micro cap stocks are stocks below $500 million or $250 million. We operate our Hummingbird fund with an average market cap of $40 million and our Tarsier fund with an average market cap of like $8 million.
Jacob Wolinsky: Can you clarify for the readers regarding the two funds you run?
Paul Sonkin: We have two funds; the Hummingbird Value Fund and the Tarsier nano-cap value fund.
Jacob Wolinsky: I assume due to the tiny size of the companies you invest in you are forced to take a large stake in the company?
Paul Sonkin: Yeah sometimes we own 5 to 10% of a company. In one case we own over 20% of shares outstanding and 65% of the float.
Jacob Wolinsky: Are you forced to take an activist role due to this?
We have taken an activist role in the past but it is something I shy away from. We focus on companies that are shareholder friendly. Being an activist investor takes up an enormous amount of time.
If you look at Bill Ackman and Michael Price who I both know and think are phenomenal investors what they do when they take an activist role is they will take a very large position. Like Bill Ackman had his Target Target fund, so they have much more concentrated portfolio.
Jacob Wolinsky: And in general you have a more diversified portfolio?
Paul Sonkin: Yes we have a diversified portfolio.
Jacob Wolinsky: Is that due to the forces of circumstance or do you prefer having a diversified portfolio?
Paul Sonkin: Its really both. By default I don’t like positions more than 5% of the portfolio. And in both funds around 10-20 positions will be about 50% of the portfolio while another 100 stocks will make up the remainder. But we have quite a few 5% positions.
Jacob Wolinsky: You are a professor at Columbia University and you run a limited partnership. Do you see your future as more of a value investor or a value thinker like Bruce Greenwald and Roger Lowenstein? Or both?
Paul Sonkin: I would say both. What I really enjoy about teaching it gives me time to research on the research process. A lot of the materials I have start as lecture. It is hard to know where the money manager starts and the teacher begins. I really try to integrate them both and I really try to bring a lot of live theses into my class.
Jacob Wolinsky: A lot of the current value investors are stepping back from their roles or will be in the future due to their age. Charlie Munger, Warren Buffett, Martin Whitman and David Dreman are all getting older. Other than yourself, who do you see as the current rising stars of value investing to lead the next generation?
Paul Sonkin: I see a lot of great money managers who all run small funds now. I don’t think these investors will come from big organizations. I think it will be small guys you never heard of, and they will remain below the radar screen for a long time. So I don’t know if that old guard is really going to be replaced.
You do have people like Bill Ackman, Rich Rubin of Hawkeye, David Einhorn, maybe Dan Loeb. I don’t really know. I think in doing what I do it is not going to make you rich and a lot of guys want to get rich. Because in the small cap world you can only get so big. There are very few people in the micro cap and small cap world making millions of dollars.
So I don’t know who the new guard will be.
Paul Sonkin coauthored Value Investing: From Graham to Buffett and Beyond (Wiley Finance). In addition there is a chapter in the book that discusses Sonkin’s investment style.
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