Most of Friday I spent as judge at the Global Investment Research Challenge for Washington, DC and Baltimore. I really like working with students. They are so earnest, and they work so hard.
Last year, the company was Under Armour, which was tough because it was a growth company. Very difficult to value. This year, the company was Marriott (MAT), which I think is even harder to value because of its asset-light strategy. Further, they have bought back so much stock that not only is the company’s tangible book value negative, but the unadjusted book value is negative too.
But for what it is worth, the students this year had similar views about the target company, and the range of target prices was small versus what I saw with Under Armour (NYSE: UA).
But when I listen to the students, I sometimes cringe, because I’ve studied statistics to a far higher degree. Now, when I judge, I don’t take my views into account, because I know I am in the minority, and the students don’t know that they are getting bad methods for analysis. Let them listen to their professors, who don’t have a clue as to how the economy really works, and express what they have learned.
But if I had control over what Finance students were taught, I would do the following:
1) I would reduce the math content for finance students and increase the qualitative understanding of markets. No more MPT.
2) I would increase the level of understanding on how to relate with people, because that makes a big difference in negotiating trades.
3) I would want them to work in a simple business, like a hot-dog cart, or mowing lawns, so that they could begin to get an idea of how tough it is to earn a profit. My best boss in my life grew up watching his parents’ delicatessen, and it shaped his view of how to make a profit. I didn’t have that as a kid, but I did have two parents who pointed out to me that life wasn’t easy. The profits of my Dad’s business were by no means certain, and evaporated in the early 80s. My Mom reinvested much of my Dad’s earnings into her stock portfolio, far exceeding what most investors achieve, but with periods that would make you wonder. I partly paid for some of my college education by encouraging my Mom to buy a company that she previously sold that several years later went private for a handsome price.
4) I would revise the concept of the cost of capital to make it credit-centric. All the efforts to calculate the cost of equity capital from equity market correlations are bogus. They don’t make any economic sense. In most cases, the cost of equity should not exceed the yield on an average CCC bond.
5) I would tell them that changes in inflation and real GDP don’t have as large of an impact on corporate profits as is commonly thought, both positively and negatively. I would tell them to focus on the stock, and drop the complex model. Few in the investment business work off a complex model, and if you need one, you can buy Value Line, which I like, which tries to use a single macroeconomic model for 1700 popular stocks. (and I get the model for FREE, because my county library subscribes to the WHOLE ENCHILADA, and I can ride on their back. Morningstar too.) I’m generous with my insights, but I rarely pay for services, because I know that they can be obtained cheaply, most of the time.
I would teach students to think on a higher level. Not this causes that, but this influences that, and a lot of other effects occur as a result. This is similar to Howard Marks’ concept of “second level thinking.”
By the way, I would do the same thing for the SOA and CFA syllabuses. Modern Portfolio Theory is garbage, and needs to be abandoned. We understood the markets better prior to MPT,
I would teach students that markets are not neutral, and that there are people out there trying to deceive you. I’ve had more than my share of charlatans that I have had to oppose.
In place of randomness, and statistics that imply randomness, I would teach about margin of safety, and tell them, “Do your hard work. Analyze likely profitability. Analyze free cash flow. Analyze the likelihood that you are correct; make sure the price at which you are buying includes a significant margin of safety.”
I would tell them to analyze free cash flow. Today, with the company Marriott (NYSE:MAT), that was the only thing that mattered. One team hit the nail on the head. The rest did not. The team that hit the nail on the head is going to Toronto to compete in the North American competition. Should they win, they go to the final round, I know not where.
Anyway, that is a start. As with Warren Buffett, who always thinks of what is the best way to earn and compound earnings, it is far better to analyze successful businesses than to analyze what academics think about business. After all, what, academic has created a successful business? Few, if any.
By David Merkel, CFA of Aleph Blog