Interview With Kovitz Investment Group On High Quality Investing by Lukas Neely, Endlessrise Investor
Long-Term Perspective Wins
Kovtiz Investment Group explains why they focus intently on identifying the moat of a business, how their days are structured for their success, how they were influenced by Warren Buffett as a person and investor, and why they see upside in Boeing, Jacob’s Engineering, CBS, and Bed, Bath, & Beyond.
Since its founding in 2003, Mitch Kovitz and Jonathan Shapiro have built an incredible team at Kovitz Investment Group (KIG). The addition of Joel Hirsh in 2006, makes the team all the more vigorous in their search for high quality businesses that offer out-sized return potential with a low probably of permanent capital loss. They will be the first to tell you that their approach is a little “old school” and unconventional to others in the industry, but they wouldn’t change their approach for anything in the world.
It’s hard to argue with their results. In fact, their returns have been downright stellar. Since inception, KIG has returned 11.17% vs. 7.81% for the S&P 500.
Currently, the team is finding value in high quality businesses that they believe are mis-priced by the general marketplace. They are finding value in such industries as airplane manufacturing, media, construction services, and retail.
How did you get started in the investing world? And how has your view of investing evolved (if at all)?
Mitch Kovitz: It began in 80s when I left the world of accounting. Once I began my career in the investment advisory business and asset management business, I started looking for people who were beating the markets, and doing well versus their competition. Mainly because most of the track records I had seen were not doing any better than Index funds, which were just coming into vogue.
They had been around since the 70s. But people started to realize that passive investing had done very well. So in making sure that I was still adding value to my clients, I actually stumbled upon Peter Lynch. I read all his books, and in his books he talked about Warren Buffett being the ‘best investor of all-time.’ It’s hard to believe, but I didn’t know much about Warren Buffett. At the time there were a lot of people in the investment business that didn’t follow the value stripe. And if you didn’t follow value investing back then, there was a chance you would not have known of his investment philosophy.
I started to read about him. I read all of his investment letters and quickly discovered that I was very compatible with how he thought about investing. There was a system and process (a roadmap) I thought I could use to generate market beating returns. And actually execute it over the long-term. So it all started in the mid-90s when I was actually executing the system. Nowadays I am focused more on a growing asset that is undervalued. Meaning, I focus on great businesses rather than just asset prices.
You never know when the discount between current price and intrinsic value will close. For instance, if the asset itself doesn’t grow in value for the next 5 years, more than likely your rate of return won’t be so great. However, if we invest in great businesses where the intrinsic value keeps growing, we give ourselves a better opportunity for compounded returns. I am also much more paranoid of a disappearing moat than I used to be. Changes seem to occur much quicker these days compared to when I first started in this business in the later 80s. Whether it’s increased amounts of capital chasing in great ideas or the advent of the internet, competitive moats seem to be constantly under attack.
What does your typical day look like from beginning to end?
MK: For us it’s all about gathering information, and then giving ourselves time to think. This means reading newspapers (New York Times, Financial Times, Wall Street Journal) and circulating all kinds of intelligent information among the three of us. What’s probably most telling about us is what we don’t do compared to other companies in our business. We don’t have any organized regular investment meetings. We don’t believe it’s a good idea to have a situation where you feel forced to come up with great investment ideas every week. Most of the time you get the best results in Investing by doing absolutely nothing.
“Take Time To Think.”
When there is a call to do something and constantly produce investment ideas with regularly organized meetings, it can cause harmful action. In order for a discussion to occur one of us has to send an email or walk in the other person’s office and say, “it’s time for us buy this” or “it’s time to sell that” or “it’s time to pare down here.” We let that process dictate the discussion, not an organized regular meeting.
Jonathan Shapiro: It’s not overly unique, but I typically start the day digesting the news flow of the day on companies we own or are looking at. Essentially trying to get the “lay of the land.” We also look at other companies’ news that may influence an industry. We are always on the look-out for how it could come back to impact our companies. Other than that, we are just reading. Typically, if we’re in the middle of looking at a company for potential purchase, I spend the time reading and getting as much information as I can. And other days when there’s nothing urgent or time sensitive, I’m just trying to increase my knowledge base. It’s been really important for us for the last several years.
For example, we didn’t know a great deal about the energy or media industry 3-4 years ago. But over the last couple of years, we’ve really begun to understand the nuances of these industries. It really helps us gain conviction in our decisions of specific companies.
Joel Hirsh: There aren’t many professional investors that “really” look out several years. Everyone says they look out several years, but very few actually execute on this philosophy. What really differentiates our day compared to the rest of the industry, is that we spend most of our day reading and thinking. Sometimes I will even read books during the workday. I don’t know how many professional investors take the time to read books. Charlie Munger and Warren Buffett talk about this topic regularly. You want to expand your knowledge base to gain the confidence to make only a couple of decisions a year that you’ll have to live with for years. I think it’s critical to our success. That’s what our day is set-up to accomplish: learn. Energy is a great example. We did a lot of reading in 2009/2010 on the oil and gas sector, that didn’t really matter for years. But it became enormously valuable to us years later.
“Never Feel Obligated To Act.”
What’s a little known secret about KIG that few people know about?
Mitch Kovitz: We have a fairly significant long/short complex. Lots of people don’t know about it, but we manage about $500 million. And we’ve been managing that long/short portfolio since 1998. Since that time the long/short portfolio has generated net returns just north of 14%.
Who are the people that inspire you the most? And why?
Mitch Kovitz: Two people had an enormous impact in my life, and it’s amazing how similar they are as far as their character. One is my father, and the other would be Warren Buffett. My father got me started in the business, and he showed me how to operate as a human being and professional. He has an unbelievably strong moral compass, and as a result, it helped me to operate with integrity throughout my life. He would say, “Professionals should always do what’s best for their customers. Clients don’t come to you simply to execute their ideas for them. You do customers a great disservice if you succumb to their own desires at the expense of their financial well-being.”
It takes tremendous will-power at times because of “career risk.” Doing what’s best for the client can sometimes go against their own biases, as well as underlying market trends. If the grain starts to go against you for a long time, people start asking you, “Hey, what are you doing?” But this philosophy has kept us out of very bad situations such as, not buying internet stocks leading up to the crash in 2000 and not buying commodity stocks in 2007. There can be tremendous career risk when you under-perform for a period of time. But in the end you have sleep at night, and act with integrity and doing what you say you were going to do without deviating. In this way, my father certainly had a major impact in how I operate as a professional.
Warren Buffett is another person that inspired me because of what he stood for as a person. It’s very similar to my father. Buffett of course laid out a system to generate market beating returns, and instead of keeping to himself, he willingly gave away the recipe (the secret sauce). He did this without asking for anything in return, just as Benjamin Graham did for him. He wouldn’t have gotten to where he was without someone being kind to him, so he extended that generosity 100-fold.
It amazes me that still to this day that many professional investors don’t follow the system. It’s just remarkable to me. Buffett’s character cannot be overstated enough. I remember reading a quote from Buffett a couple of years where he said, the last 40 years of his life, he has derived unbelievable benefit from how he acted in the first 40 years of his life. He’s capitalizing now on all the good things he did the first 40 years. And it shows. People want to be around him. Just think about all the businesses that sell to him below market prices because they want to be part of his empire.
Think of the people that call him when they need a partner or an investor. Whether it’s Goldman Sachs (GS) or General Electric (GE). They do this because they know he’s going to operate in good faith and do what he says. It just made so much sense to me as an individual. That’s how we want our clients to see us.
JS: To use a recent example, I was just talking with my kids about the Brian Williams situation at NBC. As Buffett says, “it takes 20 years to build a reputation and five minutes to ruin it.” If you think about that, you’ll do things differently.” Everything you do and say will have positive or negative ramifications in the future. You want to be thinking in terms of how this will affect my credibility. Ultimately that’s all you have in life. Doing something to jeopardize that is the last thing you can afford to do as a person.
JH: In my particular case, I came from a computer science background. If Mitch hadn’t given me Xeroxed copies of every letter that Buffett had written during our first lunch together, I would’ve probably structured derivatives for a living. Those letters were very impactful, and it’s obvious as soon as you read them. To tell you tell you the truth, I’ve always wondered why it’s not obvious to many. I would say I have learned the most from Warren Buffett, Joel Greenblatt, as well as these two guys (Mitch and Jon).
What is your philosophy and process to investing?
JH: We try to estimate a fair value price that the company would be worth if it was sold in its entirety to a reasonably knowledgeable buyer. We do so using a long-term outlook of at least 3-5 years. And the actual method we use to determine our fair market price can deviate by the type of company. But essentially we are looking for high quality businesses with a readily identifiable moat that we believe to be sustainable. We also need to articulate why it’s sustainable, and then we want it to trade at a significant discount to our fair value estimate to build in a margin of safety.
JS: Generally, we don’t do a great deal of screening. But we have done is put together what we consider our universe of investable stocks. And that’s based on the quality of the business, competitive advantages, and businesses that don’t change too rapidly. We’ve put together this list over the years, and every week we are adding or taking businesses out. Right now it’s probably 450, and we just focus on those companies. Those are the businesses we want to own if they’re selling at the right price. Essentially we are taking the universe of 10,000 publically traded stocks, and we are distilling it down into 400-500 businesses that we focus on intently. At any point in time, usually 300 or more of those businesses are trading at nowhere near a price that we would be interested in owning it.
JH: I would say we operate somewhat separately and as a group. We’re all doing our own reading. We all do our own research, and then we are updating each other if a stock gets to a point where one of us is interested. At that point it would cue the other two to take a look and see if it has the potential for investment. We really go out of our way not to influence each other. And I think that has served us very well.
“Only A Few Drivers Really Matter To Any Investment.”
JS: Within our own individual frameworks, we all have a good understanding of what a good business looks and smells like. So we have a like mindset on the kind of companies we would be interested in buying. At that point it’s all about ascertaining what the individual company is worth and then hopefully buying it at a significant discount to that price. Whenever we all think a stock is getting near those levels, then we all get involved.