Whitney Tilson: Selected Published Columns
Whitney R. Tilson
New York, NY
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Summary of Each Column
- The Arrogance of Stock Picking (1/3/00; http://www.fool.com/boringport/2000/boringport000103.htm). I wrote that “I wholeheartedly endorse stock picking, but only for people with realistic expectations, and who have what I refer to as the three T’s: time, training, and temperament.”
- Thoughts on Value Investing (11/7/00; http://www.fool.com/news/foth/2000/foth001107.htm). I shared my thoughts on what value investing is — and isn’t.
- Valuation Matters (2/7/00; http://www.fool.com/boringport/2000/boringport000207.htm). Back in early 2000, arguing that one should think about valuations when purchasing stocks was heretical, but I wrote: “I believe investors in [the hottest] sectors are setting themselves up for a fall, not because they’re investing in bad businesses, but because the extreme valuations create a highly unfavorable risk-reward equation. I suspect many are not investing at all, but are simply speculating in a greater fool’s game.”
- Valuation STILL Matters (2/20/01; http://www.fool.com/news/foth/2001/foth010220.htm). With stocks down a year later, I argued that focusing on valuations was even more important.
- Bargain Shopping in Uncertain Times (10/2/01; http://www.fool.com/news/foth/2001/foth011002.htm). With investors panicking after the September 11th attacks, I wrote that “the best time to buy stocks is when uncertainty is at its greatest, because that is when prices are often at their lowest.” The nine stocks I recommended rose an average of 38% by the end of 2001.
- Should Warren Buffett Call It Quits? (4/3/00; http://www.fool.com/boringport/2000/boringport000403.htm). After the tech stock bubble led to famed value investor Julian Robertson calling it quits, some wondered whether Buffett was next. My answer was “an emphatic no.”
- Perils and Prospects in Tech (10/9/00; http://www.fool.com/boringport/2000/boringport001009.htm). I said that the tech “bubble hasn’t finished bursting yet” and argued “that it is a virtual mathematical certainty that [Cisco, Oracle, EMC, Sun, Nortel and Corning], as a group, cannot possibly grow into the enormous expectations built into their combined $1.2 trillion dollar valuation.” I concluded: “Investing is at its core a probabilistic exercise, and the probabilities here are very poor. If you own any of these companies and, for whatever reason (such as big capital gains taxes; hey, I don’t like paying them either) haven’t taken a lot of money off the table, be afraid. Be very, very afraid.” Since then through the end of 2001, these six former market tumbled an average of 78%.
- Cisco’s Formidable Challenge (10/23/00; http://www.fool.com/boringport/2000/boringport001023.htm). I elaborated on Perils and Prospects in Tech, showing why Cisco was almost certainly overvalued and arguing that a terribly out of favor stock like Apple was a better bet due to the extreme discrepancy in their valuations. Since then through the end of 2001, Apple rose 1% and Cisco fell 68%.
- Sustainable Competitive Advantage (2/28/00; http://www.fool.com/boringport/2000/boringport000228.htm). Quoting from Warren Buffett and Michael Porter, I underscored the important of strategy and sustainable competitive advantage.
- Traits of Successful Money Managers (7/17/01; http://www.fool.com/news/foth/2001/foth010717.htm). I argued that successful long-term money managers share 16 traits, divided equally between personal characteristics and professional habits.
- The Perils of Investor Overconfidence (9/20/99; http://www.fool.com/BoringPort/1999/BoringPort990920.htm). In the first column I ever published, I discussed the many ways in which people’s emotions can undermine their investment decisions and performance.
- A Little Perspective (4/17/01; http://www.fool.com/news/foth/2001/foth010417.htm). I have a soft spot for this column, in which I shared my experiences from a trip to visit my parents in Ethiopia.
The Arrogance of Stock Picking
By Whitney Tilson ([email protected])
Published on the Motley Fool web site, 1/3/00
NEW YORK, NY (Jan. 3, 2000) — One of the best columns I’ve ever read on The Motley Fool — or anywhere else for that matter — was penned by former Fool Randy Befumo. His Fool on the Hill article, written on November 12, 1997, was entitled “When NOT to Invest.” (The article appears in the old Evening News format, so make sure to scroll down past the “Heroes” and “Goats.”) I’m afraid I won’t be as eloquent as Randy, but I’d like to highlight some of his ideas and add a few of my own.
I hate to start the new year by saying something a lot of people aren’t going to want to hear, but I think it needs to be said, and given what’s going on in the market, it needs to be said sooner rather than later. I believe an awful lot of people who are investing in individual stocks shouldn’t be doing so. I realize that as a professional money manager, that sounds self-serving and arrogant, but hear me out.
Over the past 25 years, Americans have enjoyed the most remarkable period in the history of the stock market. During that time, the S&P 500 Index has only declined in three years, the worst being a mere 7.4% decline in 1977. The S&P was even up 5.1% in 1987, a year best remembered for the 20-plus percent crash in a single day in October. And the past five years have seen an unprecedented 20% or greater increase each year (the old record was two consecutive years). Little wonder that millions of average Americans are flocking to the stock market.
As I wrote in a recent column, I think this is great, as stocks have always provided superior returns vs. bonds and T-bills for long-term investors. And despite the market’s high valuation levels today, I expect this will continue to be the case for investors with at least a 20-year time horizon. But the means by which people are investing in stocks concerns me. Rather than investing in diversified funds run by professionals — or, better yet, in index funds — record numbers of people are picking stocks on their own. Despite the mantra preached on this website, I think this is a mistake for many — perhaps most — people.
Why do I believe this, especially given the success that individual investors have had in recent years? Because I think that beating the market over long periods of time will be difficult and will require a number of things (discussed below) that most people don’t have. Based on what I read in the media, on message boards, and in e-mails I get from readers, I fear that many people have been drawn into the market because they felt like they were missing out on a party in which everyone else was partaking. Just buy large-cap, brand-name stocks, especially riskier stocks in the tech/Internet area — and maybe some IPOs as well — and you’ll get rich quick. You know what? There’s been nothing but positive reinforcement for this approach, which of course lures more people to the party and leads everyone to invest even more money (or, heaven forbid, start borrowing money to invest). To some extent, this phenomenon creates a self-perpetuating cycle, but I don’t believe it can go on forever. Burton Malkiel, author of the brilliant book A Random Walk Down Wall Street, wrote an eloquent article, “Humbling Lessons From Parties Past,” about this in yesterday’s New York Times that I urge you to read.
Let me be clear: I’m not a bitter money manager who has trailed the market (quite the opposite in fact) and who expects a collapse of today’s high-flying stocks. I even own some of these stocks — Microsoft, for example. But, I don’t own them because they’re popular. I own them because I feel that I have a strong understanding of their businesses, economic characteristics, and competitive positions, and believe that the companies will do well enough over the many years I intend to own them to justify their high current valuations. I don’t kid myself about the risks in these stocks, and am careful to diversify by owning some value stocks and small- and mid-cap stocks.
Who Should Invest in Individual Stocks
I wholeheartedly endorse stock picking, but only for people with realistic expectations, and who have what I refer to as the three T’s: time, training, and temperament.
We all know the statistics about the percentage of highly trained mutual fund managers with enormous resources at their disposal who have trailed the S&P 500 Index — well over 90% over the past five years. On average, individual investors also underperform the market for many of the same reasons, taxes and trading costs in particular (see Odean and Barber’s landmark study of 78,000 individual investors). Given these odds, it takes real confidence, bordering on arrogance (or perhaps just naivete), to try to beat the market. And I’m as guilty as the next person. So why do most people try? I explored some of the reasons in my column on “The Perils of Investor Overconfidence.”
Before I started managing money professionally on a full-time basis, I was doing what most of you were doing: investing in stocks part-time while holding down a full-time job. In retrospect, though I was having success, I realize that it was due in part to good fortune, not because I truly understood the companies and industries in which I was investing. Today I have a much deeper understanding — and I have the time to research more investment ideas — both of which I believe give me a better chance of beating the market in the long run.
I know that Philip Fisher and others who I respect immensely say that once you’ve picked a few good companies, it requires no more than 15 minutes per company every three months to review the quarterly earnings announcements, but I just don’t think this is realistic — especially if you’re investing in companies in the fast-moving technology sector. Were I no longer able to invest full-time, I think I would put most of my money in index funds.
Remember the first time you ever tried rollerblading or skiing? You were probably a little wobbly and started by going slowly and learning how to turn and stop. Of course, nothing prevented you from heading for the biggest hill, but I hope you had the good sense not to. Or maybe you didn’t, but ask yourself: even if you didn’t crash, was it a good idea? Investing is much more difficult than skiing or rollerblading — and the consequences of mistakes can be severe — yet countless people are buying stocks without the foggiest notion of what they’re doing.
Identifying and exploiting market inefficiencies is the key to successful long-term investing. To do so, you need appropriate skills and training to understand at least a few industries and companies, and think sensibly about valuations. In his column, Randy outlined a number of hurdles:
“In my opinion, you should NOT be investing in stocks… if you cannot define any of the following words: gross margin, operating margin, profit margin, earnings per share, costs of goods sold, dilution, share buyback, revenues, receivables, inventories, cash flow, estimates, depreciation, amortization, capital expenditure, GAAP, market capitalization or valuation, shareholder’s equity, assets, liabilities, return on equity.” To this list, I would add the flow ratio and return on invested capital, among others. How many people have even these tools, much less the many others required to be a successful long-term investor?
Learning these things isn’t overly difficult and — I can assure you based on personal experience — doesn’t require an MBA. But it does require quite a bit of time and effort. So where should you start? I, for one, taught myself almost all of what I know about investing by reading (here are my favorite books and quotes on investing). Warren Buffett and Charlie Munger were asked this question at last year’s Berkshire Hathaway annual meeting. Munger replied, “I think both Warren and I learn more from the great business magazines than we do anywhere else…. I don’t think you can be a really good investor over a broad range without doing a massive amount of reading.” Buffett replied, “You might think about picking out 5 or 10 companies where you feel quite familiar with their products, but not necessarily so familiar with their financials…. Then get lots of annual reports and all of the articles that have been written on those companies for 5 or 10 years…. Just sort of immerse yourself.
“And when you get all through, ask yourself, ‘What do I not know that I need to know?’ Many years ago, I would go around and talk to competitors, always, and employees…. I just kept asking questions…. It’s an investigative process — a journalistic process. And in the end, you want to write the story…. Some companies are easy to write stories about and other companies are much tougher to write stories about. We try to look for the ones that are easy.”
Numerous studies have shown that human beings are extraordinarily irrational about investing. On average, we trade too much, buy and sell at precisely the wrong times, allow emotions to overrule logic, misjudge probabilities, chase performance, etc. The list goes on and on. To invest successfully, you must understand and overcome these natural human tendencies. If you’re interested in learning more, see the books and articles I recommended at the end of my column on “The Perils of Investor Overconfidence.”
What About the Fools?
What I am saying here is in many ways in contrast to what The Motley Fool stands for (and it is to their credit that they are publishing this heretical column). For example, in the Rule Breaker Portfolio a few days ago, David Gardner wrote:
“In August of 1994, we began with $50,000 of our own money. The aim was to demonstrate to the world what was our own deeply held faith: Namely, that a portfolio of common stocks selected according to simple Foolish principles could beat the Wall Street fat cats at their own game. We’re simply private little-guy investors — not a drop of institutional blood in us — taught by our parents, by our own reading, and by our experience as consumers and lovers of business. And there’s not much more magic to it than that.”
These average Joes have compounded their money at 69.6% annually since they started in 8/5/94. If they can, why can’t you? A number of reasons. I think they would admit that they’ve been lucky, but it’s clearly more than that. I’ve met the Gardners and read a great deal of what they’ve written over the past four years. They are most certainly not average Joes. They live, eat, and breathe investing, adhere to a disciplined investment strategy, generate and analyze investment ideas among a number of extremely smart people, and are very analytical and rational.
What About the Dow Dogs and Other Backtested Stock-Picking Methods?
This topic warrants a separate column, but I’m generally skeptical of backtesting (boy, am I going to get a lot of hate mail for this one!). I’ve looked at the various methods in the Foolish Workshop (Keystone, Spark 5, etc.) and my main concern is that all of these methods have only been backtested to 1986 or 1987. I know that might sound like a long time, but it’s not, especially given the steadily rising market during this period. I’m not much interested in methods that will do well should the market continue to soar — we’re all going to do fine if that happens. I’m more concerned about a scenario such as the decade of the 1970s repeating itself. In this case, I don’t think the Foolish Workshop methods will work very well. Think about it: What if you had backtested various strategies in 1982. I’ll bet the most successful methods would have involved buying many natural resources companies — which would have been a disaster as an investment approach going forward.
But what about the Foolish Four and other Dow Dog strategies, which did very well during the 1970s, and for which there is data going back to the early decades of this century? I think there is more validity to these approaches, but I’m still skeptical of blindly following them — instead, I use them as a source of investment ideas.
The bottom line is that I don’t think there’s any substitute for doing your homework and truly understanding the companies and industries in which you’re investing.
It’s hard for me to discourage anyone from investing in stocks because I enjoy it so much. I find it fascinating to learn about companies and industries and observe the ferocious spectacle of capitalism at work. To me, watching Scott McNealy and Bill Gates and Larry Ellison go head-to-head is the best spectator sport going.
But I don’t think picking stocks is going to be as easy going forward as it’s been for the past few years, and I fear that many people are in over their heads and aren’t even aware of it. As Warren Buffett once said, “You can’t tell who’s swimming naked until the tide goes out.” Who knows? Maybe I’m swimming naked too.
I understand why people don’t invest in index funds — it’s natural to want to do better than average. But the refusal to accept average performance causes most people to suffer below-average results, after all costs are considered. I encourage you to invest in individual stocks, but only if you’re willing to take the time and effort to do so properly.
— Whitney Tilson
Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at [email protected] To read his previous guest columns in the Boring Port and other writings, click here.