“If no forces interfere with the process of entry by competitors, profitability will be driven to levels at which efficient firms earn no more than a “normal” return on their invested capital. It is barriers to entry, not differentiation by itself, that creates strategic opportunities.” – Bruce Greenwald
Background & Bio
Professor Bruce C. N. Greenwald holds the Robert Heilbrunn Professorship of Finance and Asset Management at Columbia Business School and is the academic Director of the Heilbrunn Center for Graham & Dodd Investing. Described by the New York Times as “a guru to Wall Street’s gurus,” Greenwald is an authority on value investing with additional expertise in productivity and the economics of information.
Greenwald has been recognized for his outstanding teaching abilities. He has been the recipient of numerous awards, including the Columbia University Presidential Teaching Award which honors the best of Columbia’s teachers for maintaining the University’s longstanding reputation for educational excellence. His classes are consistently oversubscribed, with more than 650 students taking his courses every year in subjects such as Value Investing, Economics of Strategic Behavior, Globalization of Markets, and Strategic Management of Media.
Greenwald is a senior adviser to the First Eagle Investment Management Global Value team, having initially joined First Eagle Investment Management as a consultant in September 2007. Bruce received his BS in Engineering from MIT and holds an MS and MPA from Princeton University. He also earned his PhD from MIT.
First Eagle Funds
First Eagle is an independent firm with approximately $100 billion in assets under management. The firm began life in Germany, before moving to New York City in 1937. From the group’s website:
“Drawing from the investment philosophies of Benjamin Graham and Warren Buffett,the First Eagle Global Fund seeks to achieve positive absolute returns over the long-term through a fundamental, value-oriented approach that seeks to avoid the permanent impairment of capital by investing with what we believe is a margin of safety.
The First Eagle Global Income Builder Fund applies this long standing approach to an income-oriented strategy in an effort to help investors balance the need for current income with the capital appreciation needs of tomorrow. We believe clients should consider these complementary offerings in building robust portfolios to help them meet their investment objectives.”
If you want to get a really good sense of Bruce Greenwald’s value philosophy it is really hard to describe in a few paragraphs. I would recommend reading his book Value Investing: From Graham to Buffett and Beyond .
The best way to describe Greenwald’s investment philosophy is through two quotes. The first, from an interview with Morningstar:
Morningstar: “…Can you give us your thoughts on how value investors should approach owning highly leveraged financial names like Citigroup?”
Greenwald: “OK, let me start with how we do it, and then I’ll talk about how they will do it slightly differently. For First Eagle, preservation of capital is the first priority. We would love a 9%, 10%, 11% return for our investors, above inflation in the long term, but we’re not prepared to risk capital to get that.
When you look at the financials, the big downside is from the leverage…
When we look at the value, which is there in terms of earnings power, but then we look at the potential for permanent impairment of capital–because if they lose all that money, they’re going to have to issue stock at unfortunate levels–for us the risk is just too high.
For other value investors, if you are willing to invest with a four to five times upside and lose all your money, obviously it’s a more attractive proposition. So I think that really is the issue, is that they’re very highly levered…”
Morningstar: “…First Eagle owns is American Express, terrific business. How does the price look, though? It’s up substantially in the last 12 months.
Greenwald: It is up substantially; if you think that they’re capable of earning, in the long run, $3.60 a share. I’ll do it in share terms. It’s still a 10% return. So, for us, the judgment that we’re making is–because there’s some growth there obviously–the judgment that we’re making is that the risks are tolerable…
And there are two reasons for that. One is, their credit card defaults are actually falling, and have been falling for a long time. And the second thing is, they’re shrinking their loan portfolio, and it’s generating a huge amount of cash…
So, again, since our emphasis is first on preservation of capital, that’s the one financial we’re prepared to do, because it’s a good return. Not as great a return perhaps…It’s a good return, but the risk of permanent impairment of capital is almost nil for them.”
You can read the full interview on Morningstar here.
The Second interview is from Advisor Perspectives:
“…There are three principles that I believe good risk managers and value managers should pursue to protect themselves from permanent impairment of capital and variance.
The first principle is that the quickest way to permanently impair your capital is to overpay for something. So you always want to have a margin of safety.
The second issue is that, you go wrong with your margin of safety because your intrinsic value is wrong. Something happens that surprises you. That is almost always – if it’s a permanent impairment of capital – a company problem, where a product doesn’t work or a competitor comes in, or an industry problem, like newspapers, where they get destroyed…
For the sake of risk management, you’ve got to have at least 20 to 30 globally diversified positions. This second lesson of diversification applies because the risk of permanent impairment of capital tends to be unsystematic and specific to impairment of capital management and to variance management…
The third rule is that, even within a diversified portfolio, if you have if you have a total loss that affects 3% to 4% of your portfolio, you are asking for trouble. The thing that will convert temporary impairments, which are the macro fluctuations, to permanent impairments is leverage…We’ve learned that if you want to do a stub, which is a highly leveraged position, you want a five- to six-times upside, because the downside is zero. You’ve got to start thinking in those terms. People have learned to think about leverage differently and to be warier of leverage, and only be willing to do it in a restricted part of a diversified portfolio.
Interviewer: Some of the stocks you own, like Microsoft and American Express, don’t fit the traditional mold of value stocks – ugly, cheap, beaten-down, and boring. What makes these stocks attractive?
Greenwald: American Express is unbelievable. It has sustainable earnings of a minimum of $3/share. If they manage their costs at all – and that could happen if Ken Chenault leaves the company – they could easily make another $2.50/share pre-tax by cutting costs. You’re talking about making $5/share after-tax in sustainable earnings. When the price is $10, that’s two times earnings – a 50% earnings return.
If you think it is $3 or $3.50 with a potential of $5.00, you’re talking about an earnings return on American Express that’s 10% and up. They’ve got some organic growth because they earn 1.1 % on their billings [through merchant fees] without any significant impact on receivables. Rich people are clearly doing better than poor people, as they have for the last 40 years. The surprise is that these stocks, which you would not think are ugly or obscure, are this cheap. People have just gotten scared.
Microsoft is going to rule, because you need an operating system. They have pricing power. I don’t know why their stock was at $17, which I believe is where we bought it. They generate huge amounts of cash. Their stupidity seems to have stopped for the moment. They are not doing X-box or dumb things for Yahoo any more.
Interviewer: Is there any part of the media industry that is attractive economically?
Greenwald: The content business was never very profitable and the aggregation business went away with electronic distribution, so you are left with the final distribution – the pipelines. They ought to get correspondingly more valuable. They are Comcast and Verizon. They have local monopolies. Nobody is going to build infrastructure to compete with them. The issue is whether they can get along on price with the Telcos.
The one that we like best, even though they break our hearts with their stupidity, is Comcast, which is trading at a 13% earnings return because they are way over-depreciating. We think they ought to have huge pricing power. To do that, they’ve got to get along with the Telcos, but they are doing everything in their power to alienate them by going after small businesses, which has always been in the bailiwick of the Telcos. Hopefully, just like Coke and Pepsi, they will learn to cooperate.”
You can read the full interview here.
On Warren Buffett Purchase of BNI: “It’s a crazy deal. It’s an insane deal. We looked at Burlington Northern at $75 and I’ll give you the exact calculation we did. You don’t have a high earnings return. They are paying 18 times earnings, but it’s really much worse than that. They report maintenance cap-ex very carefully. They report depreciation and amortization, and they report only about 70% of the maintenance cap-ex. So they are under-depreciating, and their profit numbers are lower than the true profit numbers – and in a bad way, because the tax shield for the depreciation is undergone too. Their profitability is much lower than it looks.”
“Buffett’s paying 18-times [at $100/share] and at $75 he was paying 16-times. Our calculation is he was paying 21-times…”
“It looked to us like an oil play. He has a history of making bad oil play decisions. And that was at $75/share, we thought there were better oil plays. At $100/share we think he [Warren Buffett] has lost his mind.”
“What you want to do is to have a technology that brings all the available information to bear, so you can cross-correlate the asset values with the earnings-power values, with your judgement about whether there’s a franchise here. That if you’re going to buy growth, you’re absolutely certain that the franchise is there so the growth is going to be valuable… And then, only then, looking at the growth.”
“In the long run, everything is a toaster.”
On Value Investing: “You are looking for things that are ugly, cheap, out of fashion, etc. Ugly, traded-down, cheap, boring — as opposed to glamorous, respectable, lottery-ticket type stocks, and prominent stocks — are things that you want to be set up to look at as a value investor. So that’s the first part of it. That’s the search strategy. You have to have confidence in your valuation. And you have to have the discipline to stick with it, that if this is a good stock and nothing has changed about the underlying value of the company, then if it’s a good stock at 8, then it’s a better stock at 4, rather than people who will see a stock go from 8 to 4 and say, “Oh crap, something’s going on here that I don’t know about.” Value investing consists of three things — three things that you have to do to be a good value investor. To some extent, they are all rooted in the way Ben Graham approached things. The first thing is you have to understand the extent to which markets are efficient. It’s just inescapable that whenever you sell a stock, somebody else is buying it; and whenever you buy a stock, somebody else is selling it. And one of you is wrong. Only in Lake Wobegon can more than 50% of the investors outperform the market. So there’s an absolutely fundamental sense in which you’ve got to start off thinking that markets are efficient. You want to structure things so that you’re on the right side of the trade, that the people on the other side of the trade are, in some sense, doing irrational things…The second thing you have to have is a good technology for valuing what you’re buying… And the third thing you have to have is discipline and patience.”
- Value Investing: From Graham to Buffett and Beyond (Wiley Finance)
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- Greenwald Lecture at Gabelli Value Investing Conference (Part 1 of 2)
- Greenwald Lecture at Gabelli Value Investing Conference (Part 2 of 2)
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