Feynman Investment Research LLC is an independent investment research firm that focuses upon providing actionable and timely investment ideas on undervalued and under- recognized companies.
In this interview, we will be chatting with Brian Grosso. Grosso is currently finishing up his senior year of undergrad and jumping right into the investment business, as an investment advisor at Rugged Group, LLC, that he recently formed. I met Brian 3-4 years ago, on an investment blog on Facebook, when we were both beginning our trek down the road of investing. Since then we have bounced investment ideas off each other and have chatted multiple times. Grosso has a passion for investing, is very skilled at analyzing companies, has deep insight and understanding of business and is way ahead of many of his peers, given how young he is.
Feynman Investment Research Interviews Brian Grosso
So Brian, tell us about yourself (school, work, hobbies, etc.)
Brian Grosso: Sure Nick, Thanks for interviewing me!
I’m currently in my senior year at the University at Buffalo and will graduate with a degree in Accounting in the spring. This past summer, I interned at a large bank, which gave me a lot of perspective on Corporate America and my own personal work preferences. I’d been thinking about the possibility of opening an advisory business for several years at that point, but the internship experience and some discussions with a key mentor catalyzed me to go through with my plans. Rugged Group LLC was formed in early August and we are now over the regulatory hurdles and doing business.
As for hobbies, I really enjoy reading, walking, hiking, and spending time with family (not necessarily in that order!), as well the occasional obsession with Zynga Poker.
Has an accounting background helped you with analyzing companies? What major would you suggest aspiring student investors to jump into?
Brian Grosso: An accounting background has definitely helped. I would recommend accounting to prospective investors. Accounting is necessary to understand how businesses are performing and what they are worth. Learning accounting has led me to be much more skeptical of GAAP accrual basis numbers, because there is a good deal of discretion and assumptions involved in those numbers, and it is certainly not the only way to report results. In fact, GAAP has changed over time, if that says anything about its infallibility.
Here is a brief example of how GAAP results can be distorted. When a company has a defined benefit retirement plan for its employees (read: pension), it creates both an asset and liability. The assets are tangible – the securities that the plan actually owns such as bonds and stocks that it is trying to earn a return on. The liabilities are not – they are projected future cash outflows to employees the company will have to pay out, discounted back to the present using a discount rate. Clearly a lot of assumptions are involved and one that is problematic is the discount rate that is used. The discount rate that actuaries normally use is interest rates on high quality (AAA, AA, etc) corporate bonds. When interest rates get very low as they are now, the discount rate is very low (like 3%), and in turn the present value of the liabilities skyrockets without any change in what actually must be paid out in the future.
In reporting the plan on the financial statements, the plan assets and liabilities are netted together to get a net asset or liability. In this low-rate environment, many companies have very large pension liabilities that investors perceive as debt and are including in enterprise value calculations, but the crazy thing is that if interest rates increase 100bp or so, many of these liabilities will vanish without any fundamental change at the company. Having learned accounting, I’m much more aware of these kinds of nuances and since much of accounting is principles, if I come across a nuance that I’ve not learned directly, I can often still put the pieces together from what is disclosed in the footnotes.
That is really interesting in regards to GAAP EPS. I always use FCF myself when valuing companies, but never knew that there was an issue with GAAP when it comes to pension plans. I can really see how an accounting background has been of value to you. How did you end up picking Rugged as a name for your advisory business (I am sure it has some meaning)?
Brian Grosso: Great question. Rugged has two meanings. The first is a rough, uneven surface that is difficult to traverse. Think rugged terrain. I think this is symbolic of financial markets, or at least the way I want myself and clients to think about them. The journey to wealth through stock ownership is not an easy, straight, or paved path. There are ups and down. Big ups and downs. And it’s tough. Which brings us to the second meaning of the word rugged: strong, tough, resilient or determined in the face of challenge or hardship. These are qualities that the rugged financial terrain demands of investors. You need to be unfazed in the face of the big moves. The big red days that keep you up at night. That is hardship that needs to be overcome.
That’s a salient metaphorical name for an advisory business in relations to the overall pendulum swings of the stock market. I’ve always liked names of advisory businesses that had meaning to them, instead of just someone’s first or last name. What attracted you to the investing world?
Brian Grosso: After graduating from high school, I still didn’t really know what career I wanted to pursue. I was set to enter college as an engineering major. Early in the summer, I stumbled across some articles on Buffett and value investing. It’s funny – I had some savings from working part-time in high school and vividly recall googling “best investment strategy.” Information begot information (the internet is a wonderful thing) and I’m still digging into this endless chain of information today.
That sounds a lot like how I ended up getting into investing, I was also the same in regards to not knowing what to pursue as a career. Could you elaborate upon your investment style?
Brian Grosso: I’m a bottom-up value investor. I go through screens of mostly small, cheap stocks looking for situations where:
- I understand the business
- I expect annual returns over the next 3-5 years of at least 20-25% from the stock
- An adverse outcome does not seem to imply I am losing money, or as Mohnish Pabrai would say, “Tails, I don’t lose much”
I’m a firm believer that the future is uncertain and the way I approach valuation reflects that. There is always more than one potential outcome and I model returns for each, and then assign probabilities to get an expected return. I’ve also noticed over time that many of my worst decisions have been made very quickly, so I am trying to slow down my decision-making process through the use of watch-lists, articles, and starter positions as means of delaying gratification.
That is interesting how you have a process to delay the gratification of investing into company too fast. I feel like many investors rush into investments way to fast (also rush out of them). What kind of business models are typically out of your circle of competence? Also, how has your investment style changed overtime?
Brian Grosso: Insurance and big banks for one. After working at a big bank, I’m convinced many executives at these sorts of companies don’t even fully understand their businesses, capital structure, etc.
My investment style has gone evolved greatly over time. I’ve become much more diversified over the last few years. As I said, the future is just not knowable and that makes it hard to justify having your entire portfolio in one unknown future.
I also stray away from financial institutions due to the complexities of the business model. You have mentioned the hurdle that you use in your research before. Can you explain the hurdle to us and the parameters a security needs to jump over your hurdles?
Brian Grosso: The hurdle is an explicit attempt up front in the research process to quantify (a) the magnitude of upside an idea has and (b) the time it will take to play out, and thus (c) expected annual returns. Many investment ideas seem to generate insufficient results because they were not juicy enough or they took too long to play out. These are easy mistakes to fix early on and the hurdle is an attempt to do so. I never assume any idea plays out in less than 3 years and I don’t want to invest unless my expected total return over those 3 years is at least 80% or so (works out to 21.6% per year). Another thing to note is that a sufficiently high hurdle can be very helpful in portfolio allocation. It forces you to think in absolute terms, which may put you into a cash position when the market is peaking and good ideas are scarce.
I agree with you that having a hurdle for an investment is very important. One hurdle that I try to live by in regards to personal portfolio management is not jumping from idea to idea. I guess you could say I try to compare potential investments against my current holdings. In most cases it seems as if the ones I hold are better investments than the ones I look at. How do you control yourself from trading frequently?
Brian Grosso: I’ve noticed that in many cases, my ideas are most cherished when I act upon them. After that, if it goes up you want to sell and lock in the gain. If it goes down you want to sell and be done with it because it’s keeping you from your perfect portfolio and so you don’t have to be reminded of the mark-to-market loss (not necessarily mistake) anymore. I don’t have a firm rule here, but I’ve heard that Guy Spier won’t sell anything he buys that goes down for a year from the date of purchase. This makes him much more careful when he buys and helps him resist the subsequent emotional biases. I’m not sure I want to have such a firm rule as it may be constraining, but I’m certainly reluctant to sell things unless there’s a very good reason to do so.
Name some influencers (authors, mentors, other investors)
Brian Grosso: For investors, the usual suspects – Buffett, Munger, Mohnish Pabrai, Guy Spier, and Joel Greenblatt. However, I think the most valuable books I’ve read have been outside the investing sphere. Looking through my list, Dale Carnegie, Daniel Kahneman, and Stephen Covey’s books have probably had the deepest impact on me. Mentors have been invaluable – more important than any books. I have a few solid mentors that I communicate pretty regularly with. They are all investors, but fairly different from each other… I’m not sure they’d get along. To me, this is great because I’m exposed to a variety of perspectives and I go to them for different things.
I have a few Carnegie books on my bookshelf as well, however, I have not read any of Kahneman’s or Covey’s books before. I do agree with you that some of the most important books I have read have been outside of the investment genre. Could you list off a few books that have made an impact on your life? Also, do you believe that reading is important to successful investing?
Brian Grosso: Like many investors I am introverted. To a large extent, this comes with the territory. One book I really enjoyed was Quiet by Susan Cain. It introduces a framework where the concern is not socialization or noise, but stimuli broadly conceived. The introversion – extroversion spectrum is a measure of our sensitivity to stimuli. Introverts have a much lower tolerance. Extroverts have a higher tolerance, and in some cases even get energized from stimuli. Once you think about introversion in this way instead of just thinking about yourself as shy, you will rethink your approach to socialization, dealing with stress, relationships, designing your environment, etc. I’m not sure this is the best book I’ve read, but it definitely had a huge impact.
I don’t know that reading books is necessary, but you definitely need to be taking in information to make investment decisions and reading is the most efficient way to take in information. Books and long-form content are good for your investment process and learning concepts, but shorter stuff like blogs and articles are better for taking in actionable information. Investors need to find a balance between refining their investment process and actually investing – digging into companies and industries. This means reading a lot – but not all books.
What would your career path be if you did not go down the road of investment management?
Brian Grosso: I could talk about what I’d like it to be or what it actually probably would be. I think the latter is more interesting. If I wasn’t entering the investment management industry, I’d probably work in a large financial services firm and, for me because I am entrepreneurial, work much better alone, and investing is my passion, it would kill my motivation and I’d be unfulfilled.
Working for yourself is so much more fulfilling than working for another person. I also think that working for someone else has the tendency to be very unfulfilling, especially if it is a job that is not intellectually stimulating. Do you tend to think of yourself as a learning machine (try to learn something every day)?
Brian Grosso: Absolutely. I don’t have much to add here other than that I’ve taken a bunch of personality tests and loving to learn is one of my strongest traits. I love self-improvement.
What is your biggest weakness when it comes to investing?
Brian Grosso: There are many, but I think the one that has cost me the most money by far is what I mentioned earlier: making decisions quickly. The research process is a treasure hunt for me. It’s exciting. There’s no better feeling than discovering something and thinking “This is it! This is what I’ve been looking for and it’s going to make me and my client’s money.” Clearly there is a lot of emotion in that statement and, unsurprisingly, that’s a bad time to make an investment decision. There are many stimuli that will pressure you to make decisions at that point (see Charlie Munger’s speeches for a whole list of them), but it’s not the thing to do. Instead, you must be patient and disciplined and see the research process to fruition. You must first check all your bases, make sure all your criteria are met, and give yourself time to take in the information and fully reflect on it. The ability to delay gratification is one of the most important things I’m working on in my development now, and it’s by no means easy.
Thanks for taking the time for an interview. Where can readers get ahold of you at?
Brian Grosso: Thank you Nick! This has been a pleasure. Readers can visit my Seeking Alpha profile at seekingalpha.com/author/brian-grosso, my LinkedIn at linkedin.com/in/briangrosso, and my company’s website at www.ruggedgrp.com. My email is email@example.com. Happy investing in 2016!